Patents: A Large and Growing Source of Operating Risk

Patent lawsuits filed by non-practicing entities can place a significant drag on innovation. Here’s a game plan to minimize your exposure.

By now, most directors and executives have heard of patent lawsuits being filed by non-practicing entities (NPEs)—more commonly known as “patent trolls.” These are companies that own patents but do not use those patents to produce products or provide services. Instead, these entities are in business solely to collect licensing fees or legal settlements from the patents they own. They pursue these outcomes through litigation or the threat of litigation, against businesses whose products or services allegedly infringe on the patents.

Although the concept of patent trolls may be familiar, few members of the C-suite recognize just how large and costly a problem these businesses have become. In 2012 alone, the cost of NPE-generated litigation was nearly $11 billion, according to a recent study conducted by RPX, in collaboration with the Coalition for Patent Fairness. More than 2,400 unique companies faced at least one NPE assertion of patent infringement last year, and 270 companies fought three or more NPE lawsuits. Clearly, patent risk has become a serious strategic and operational risk.

The first step in establishing an effective strategy for mitigating patent risks is for operating companies to accept that patents are assets. Whether the USPTO should have issued so many overlapping patents is a moot point. The patents are now in circulation, and unless a legal battle proves them otherwise, the patents are legally valid intellectual property. Thus, most are assets with a financial value. The alleged users of those assets (in other words, operating companies that incorporate the patented technology into their products or services) may need to pay the owners (in many cases, NPEs) for that usage.

This is not a far-fetched notion. In point of fact, fully 95 percent of NPE patent litigations settle before a verdict. In other words, 95 percent of the time, operating companies agree to pay for their use of the patent asset. It is a classic exchange of value. Unfortunately, NPEs have built a business model that relies on the legal system to effect this exchange, and it is hard to imagine a more costly and less efficient mechanism for exchange of value than litigation. Of the $11 billion in total NPE costs borne by operating companies in 2012, fully half were legal costs; the other half comprised settlements and license payments.

A third option for dealing with NPE risk is to eschew pre-emptive buying altogether and instead deploy capital on legal defense. Some companies have adopted this “fight hard” strategy in the belief that if they gain a reputation as expensive and time-consuming to sue, they will discourage NPEs from naming them in future litigation. There is little evidence, however, that this strategy has the desired effect. From 2008 to 2011, average growth rate of case loads for defendants in NPE cases was 36 percent, and the growth rate was the same for companies that settled quickly as for those that remained in litigation for more than a year.

 

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