What is a Patent Troll and How Can I
Become One?
Financial, Ethical and Policy Considerations in
Asserting Patents in Patent Holding Companies
Presentation at KAIST October 2010
Bruce D. Sunstein
Sunstein Kann Murphy & Timbers LLP
Boston
www.sunsteinlaw.com
©2010 Sunstein Kann Murphy & Timbers LLP
What is a patent troll?
2
“—somebody who tries to make
a lot of money off a patent that
they are not practicing and have
no intention of practicing and in
most cases never practiced.”
Peter Detkin, assistant general counsel, Intel
Corp. [big target], 2001
3
—one who “must own no more
than a few patents of
questionable merit and is not in
any business related to the
patents.”
Peter Detkin, managing director, Intellectual
Ventures [patent aggregator], 2005
4
A Patent troll’s patents are in a
holding company
A holding company is often used to hold
intellectual property (IP)
An IP holding company can protect its
shareholders from personal liability if
something goes wrong in asserting the
patents
5
But an IP holding company has
unique problems getting patent
damages…
6
Because an IP holding company
has no business operations
An IP holding
holds only IP
assets: patents,
trademarks,
copyrights, trade
secrets
7
IP Holding Company:
IP Assets Only
Why does a patent troll’s holding
company have no business
operations?
The business giving rise to the patents may
already have failed; after the business has
failed, the patents remain.
The patents might get acquired by another
company in the business of asserting
patents.
Examples:
―Lemelson Medical, Education and Research
Foundation, Limited Partnership
―Acacia Technologies LLC of Acacia Research
Corporation
―Universities!
8
Note: some regular manufacturing
companies use IP holding
companies as well
Such companies sometimes put their IP
in one sister company, and put their
business operations in another sister
company.
Why do this? …
9
Taxes!
10
(often)
Taxes!
How an IP holding company can save taxes:
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Taxes!
How an IP holding company can save
taxes:
 Assumption: operations company is in a country
with high taxes
 Put the IP holding company in a country with low
taxes (or none) on royalties
 Operations company pays royalties to the IP
holding company and deducts the royalty expense
on its tax return
12
The Scheme
In country where
royalties are not
taxed
In high-tax
country
IP License
IP Holding
Company
Operations
Company
(Deducts royalty payments
on tax return)
13
Royalties
(Result: pre-tax royalty
payments escape tax)
The Tax Schemes Have Been
Attacked
Sometimes the transactions are disregarded
for tax purposes
Geoffrey, Inc. v. South Carolina Tax
Commission, 437 S.E.2d 13 (1993)
(Toys’R’Us denied tax benefit)
14
Limits on patent damages
recovery by an IP holding
company
Reasonable royalty: 35 U.S.C. § 284 (“Upon
finding for the claimant the court shall
award the claimant damages adequate to
compensate for the infringement but in no
event less than a reasonable royalty…”) and
the Georgia-Pacific factors, Georgia-Pacific
Corp. v. United States Plywood Corp., 318
F.Supp 1116, 1120 (S.D.N.Y. 1970)(listing
15 factors affecting determination of the
reasonable royalty)
15
Determing reasonable royalty for
an IP holding company
Georgia Pacific factor number 1: “royalties
received by the patentee for the licensing of
the patent in suit, proving or tending to
prove an established royalty”
16
The Scheme may establish a reasonable
royalty
In country where
royalties are not
taxed
In high-tax
country
IP License
IP Holding
Company
Operations
Company
(Deducts royalty payments
on tax return)
17
Reasonable
Royalty?
(Result: pre-tax royalty
payments escape tax)
The IP holding company’s dilemma
Defendant (in infringement suit brought by
the holding company) says intra-company
rates are a reasonable royalty
IP holding company says no—just for tax
purposes
Defendant says tax purposes require
following arm’s-length transaction principles
IP holding company may be stuck with its
intra-company rates for all purposes
18
Limits on patent damages recovery
by an IP holding company
A patent owner can recover lost profits only
if it can show “(1) demand for the patented
product, (2) absence of acceptable
noninfringing substitutes, (3) manufacturing
and marketing capability to exploit the
demand, and (4) the amount of the profit he
would have made.”
Panduit Corp. v. Stahlin Bros. Fibre Works,
Inc., 575 F.2d 1152, 1156 (6th Cir.)
(Markey, by designation).
19
Limits on lost profits recovery by
an IP holding company
Problem: an IP holding company has no
manufacturing or marketing capability
Problem has no solution when the IP holding
company has no manufacturing affiliate (for
example, a troll or a university)
20
Can a sister operations company
supply manufacturing capability to
an IP holding company?
No.
Poly-America, LP v. GSE Lining
Technology, Inc., 383 F. 3d 1303, 13101312 (Fed. Cir. 2004)lost profits recovery
not available to manufacturing company
holding a non-exclusive license from
sister IP holding company), cited with
approval in Mars, Inc. v. Coin Acceptors,
Inc., 527 F. 3d 1303, 1366-1367 (Fed. Cir.
2008).
21
Possible solution for companies with
business operations: keep IP upstairs
Put IP in hands of parent corporation
(No tax benefit, no licenses, no complexity)
A parent company holding a patent might
have standing to recover lost profits based
on the manufacturing activities of its
subsidiary, if it can be shown that profits of
the subsidiary would flow inexorably to the
parent. Mars, Inc. v. Coin Acceptors, Inc.,
527 F. 3d 1303, 1366-1367 (manufacturing
subsidiary had mere license from parent and
question not decided).
22
Tips for companies with business
operations—1
If you are a patent owner, make sure
that business goals, and not tax goals,
drive your IP strategy
 Business goals can be aided by a strong IP
portfolio that has maximized the potentially
available recovery for patent infringement
 Be wary of tax strategies that could undermine
damages recoveries
23
Tips for companies with business
operations—2
If you are defending a patent suit, be
sure to investigate:
 title to the patent in suit and the nature of the
entity owning the patent
 licensing and other deals involving the patent
in suit, including between related entities
24
Trolls: Ethical Issues and
Funding Structures
“Maintenance”: rendering assistance or
encouragement to a party in litigation by one
who has neither an interest in the litigation
nor any other legally justifiable reason to do
so
“Champerty”: a kind of maintenance, in which
one obtains a share in the outcome of the
litigation in exchange for rendering
assistance
25
Ethical Issues and
Funding Structures
(cont’d)
Purely contractual arrangement could run
afoul of ethical requirements
Better: transfer the patents to an LLC or
limited partnership

provide an interest in the entity to each of the
participants:
―for example, to the original patent owners, to the
funding source, and to the law firm.
26
Ethical Issues and
Funding Structures
(cont’d)
Third-party funding does not eliminate
consideration of the big issues
Same as in contingency litigation:
 How to share the proceeds
 How to conduct the litigation
 Criteria for accepting settlement
27
Sources of funding
1. Patent assertion insurance
2. Contingent fee arrangements
3. Third-party funding arrangements
 Through manager-brokers
 Direct investment
Plus: What you need to know about using
outside funding
28
1. Patent assertion insurance
Differs from normal hazard insurance
Insurer typically retains right to recoup
insurance proceeds if litigation is successful
29
1. Patent assertion insurance
(cont’d)
Typically requires that the insured did not
know of the infringement at the time of
purchase of the policy
 A big limitation
 May still be suitable sometimes for small to
medium-sized companies
Intellectual Property Insurance Services
Corporation (www.infringeins.com).
30
2. Contingent fee arrangements
Reason to worry: handling patent
infringement litigation on a contingency
basis is financing the five-or-more-milliondollar charges of such litigation
 Expert witness fees, other out-of-pockets: $2
million
 Plus appeal risk (40% reversal rate when patent
claims interpretation at issue)
31
2. Contingent fee arrangements
(cont’d)
Does the lawyer have staying power?
Experience?
32
2. Contingent fee arrangements
(cont’d)
Will costs be advanced?
Client may expect not to advance them
Ethical liability of client for costs v. collecting
them from client
33
2. Contingent fee arrangements
(cont’d)
The two key prerequisites for taking on a
proposed patent assertion case:
 Liability
 Damages
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2. Contingent fee arrangements
(cont’d)
How big must the damages be?
 Must justify $5 million through trial—plus
additional cost of appeal
 So must be much bigger than $5 million
 $15 million floor
 $25 million or more is better
35
2. Contingent fee arrangements
(cont’d)
The contingent-fee agreement
 How to share the recovery?
―Typically more than one-third
―Forty percent + is common
36
2. Contingent fee arrangements
(cont’d)
The contingent-fee agreement
 How to share the recovery?
―Subtract costs first
―Layers of sharing thereafter? Example:
• First $10 million divided evenly
• Amounts above $10 million, 33% to law firm
―Administrative expense of handling royalties?
37
2. Contingent fee arrangements
(cont’d)
The contingent-fee agreement
 What is a reasonable settlement? Parties’
expectations?
 Where should the lawsuit be filed? Nationwide
jurisdiction and venue are common.
 Expert witnesses for liability (technical) and
damages (financial).
38
2. Contingent fee arrangements
(cont’d)
The contingent-fee agreement
 Hybrid arrangement? Example:
―Discount from regular rates
―Client pays costs as incurred
―Law firm gets percentage of recovery
 Same exercise as above
39
3. Third-party funding
arrangements
Patent aggregators
Patent assertion manager-brokers
Patent assertion broker-manger-investors
Novice patent litigation investors
40
3. Third-party funding
(cont’d)
Patent aggregators build patent portfolios
that can be licensed or litigated
Patent owner typically has passive role
41
3. Third-party funding
(cont’d)
Patent aggregators:
 GE Licensing and Trading, Princeton, NJ
 Intellectual Ventures, Bellevue Washington
(www.intven.com)
 Acacia Technologies LLC, Newport Beach,
California (www.acaciatechnologies.com)
 InterDigital, Inc., King of Prussia, Pennsylvania
(www.interdigital.com)
42
3. Third-party funding
(cont’d)
Patent assertion manager-brokers consider
a company’s patents to be asserted on an
individual basis, with potential litigation in
mind
Often have relationships with patent counsel
and funding sources
Will structure funding and representation in
exchange for a percentage
43
3. Third-party funding
(cont’d)
Patent assertion manager-brokers:
 PhoneTel Patent Services, Incorporated, Ft.
Worth, Texas (www.phonetel.com)
 General Patent Corporation International,
Suffern, New York (www.generalpatent.com)
 ThinkFire Services USA, Ltd., Clinton, NJ
(www.thinkfire.com)
44
3. Third-party funding
(cont’d)
Patent assertion manager-brokers with their
own internal funding resources:
 Altitude Capital Partners, L.P., New York, New
York (www.altitudecapitalpartners.com)
 Rembrandt IP Management, LLC, BalaCynwyd, Pennsylvania (www.rembrandtip.com)
Other sophisticated investors in patent
assertion
 Credit Suisse (www.credit-suisse.com)
45
3. Third-party funding
(cont’d)
Novice patent litigation investors
 Category includes most seasoned investors
 Does not obviate need to structure the
arrangement among the parties
―Usually the patent litigation firm will handle
structuring
―Identify the issues on which parties need consensus
46
Patent troll example 1:
Eolas v. Microsoft
Researchers including Mike Doyle
at UC San Francisco develop
software, patented by UC
 licensed to Eolas, company founded by
Doyle to commercialize the software
 Microsoft turns down license but adopts
the technology
 Eolas, crowded out of marketplace, sues
Microsoft after patent issues
47
Patent troll example 1:
Eolas v. Microsoft
$521 million judgment against
Microsoft
 US patent 5,838,906 covers use of web
browser in fully interactive environment
 Verdict set aside on appeal and case
remanded for retrial, Eolas Technologies
Inc. v. Microsoft Corp., 399 F.3d 1325
(Fed. Cir. 2005)
 Patent survived two reexaminations
 Eolas settled with Microsoft in 2007
48
Patent troll example 1:
Eolas v. Microsoft
Would Eolas have been formed to pursue
Doyle’s innovation without the patent
system?
49
Patent troll example 2:
MercExchange v. eBay
Thomas G. Woolston, former Air Force pilot,
gets electrical engineering degree while
working on secure communications system
for Central Intelligence Agency, and later
gets law degree.
Invents online auction system in 1994,
writes software for it, files for patents,
forms company, MercExchange, which runs
out of money, but still has patents including
US patent 5,845,265
50
Patent troll example 2:
MercExchange v. eBay
MercExchange sues eBay, founded in 1995, a
year after Woolston’s invention, for
infringing US patent 5,845,265
Obtains judgment for $35 million, later
reduced to $29.5 million
On appeal, the US Supreme Court reverses
grant of injunction, saying injunctions
require exercise of discretion of court, 547
U.S. 388 (2006)
MercExchange settles with eBay in 2008 for
undisclosed sum in exchange for patents and
technology
51
Patent troll example 3:
Network Appliance v. BlueArc
BlueArc, a client of the Sunstein law firm,
develops a network file server implemented
using a new architecture with field
programmable gate arrays instead of a
conventional processor (and gets patents)
Network Appliance, a major competitor in
the network attached storage market,
acquires patents from bankrupt Auspex and
asserts them against BlueArc
BlueArc successfully defends on grounds of
non-infringement and invalidity
52
Patent troll example 4:
University of Rochester v. G.D.
Searle & Co., Inc.
University of Rochester obtained a patent for
work of its scientists relating to two distinct
cyclooxygenases, COX-1 and COX-2, which
are related to inflammation.
Theory: may be possible to reduce
inflammation without gastrointestinal side
effects if one could inhibit activity of COX-2
without inhibiting activity of COX-1.
Rochester scientists developed an assay to
determine if a candidate drug had such
selective inhibition.
53
Patent troll example 4:
University of Rochester v. G.D.
Searle & Co., Inc.
Rochester obtains patent 5,837,479 for a
method of selectively inhibiting Cox-2 and
sues numbers of drug companies.
Rochester loses. University of Rochester v.
G.D. Searle & Co., Inc. 358 F.3d 916 (2004)
(patent failing to disclose compound capable
of performing the claimed method is invalid
for lack of written description).
54
Patent trolls and public policy:
US Supreme Court
In eBay v. MercExchange, 547 U.S. 388
(2006).
Concurring opinion by Justice Kennedy,
joined by Justices Stevens, Souter, and
Bryer, criticizes the use of patents “not as a
basis for producing and selling goods but,
instead, primarily for obtaining licensing
fees.”
55
Patent trolls and public policy:
US Supreme Court (cont’d)
Also in eBay v. MercExchange concurring
opinion:
The threat of an injunction “can be
employed as a bargaining tool to charge
exorbitant fees to companies that seek to
buy licenses to practice the patent.” The
opinion furthermore criticized ... “the
burgeoning number of patents over business
methods”, some of which have “potential
vagueness and suspect validity”.
eBay v. MercExchange, 547 U.S. 388, 396397 (2006).
56
Patent trolls and public policy:
US Supreme Court (cont’d)
Other decisions of the Court have made it
harder to enforce patents:
 MedImmune v. Genentech, 549 US 118 (2007)
(making it easier to file an action for a declaration
of non-infringement when a patent holder seeks to
license a patent)
 KSR v. Teleflex, 550 U.S. 398 (2007) (making it
easier to challenge a patent as invalid for
obviousness)
57
Patent trolls and public policy
Trolls are often the innovators
The infringers whom patent trolls accuse:
 Big companies with market power
 That would like to use the innovations for free
 Companies with market power have less need
of patents
58
Patent Trolls: the harder case
When the patent holder stands in the shoes
of the innovator
Innovator, sold out (or forced out), is no
longer the one asserting the patent
BUT:
The patent system depends on the ability of
the innovator to sell out downstream
The innovator cannot get value for the
innovation if successors cannot enforce
So maybe patent trolls are simply a
consequence of a working patent system
59
As to a patent owner seeking
funding, the owner needs:
A counselor who:
 understands risk
 can structure a funding arrangement that
works in the complex world of patent litigation
A funding arrangement that:
 creates an alignment of interests in the
outcome of the litigation
 reflects the expectations of all the parties
 provides an equitable and ethical distribution
of the proceeds
60
Conclusion
A patent troll has
 Big risk!
 Big (potential) reward!
A company at risk from a patent troll should
 Conduct patent investigations and regularly update
them to assess risk
 Treat infringement risk seriously
Patent assertion by non-practicing entities
results from a market economy of which patents
are a part
The name “troll” for a non-practicing entity
reflects more a desire by some defendants to get
political leverage than a problem with the patent
system
61
Thank you.
Bruce D. Sunstein
bsunstein@sunsteinlaw.com
www.sunsteinlaw.com