Prof. Doug Lichtman, UCLA School of Law
June 12, 2012
Earlier this year, Yahoo made headlines when it filed a blockbuster patent lawsuit against Facebook. The basics of the case looked promising. Yahoo could credibly cast itself as an Internet pioneer; and the company has a promising portfolio of patents related to online advertising and website personalization. Naturally, commentators began to gush about the possibility of a multi-billion-dollar settlement. But then Facebook purchased 750 patents from IBM, and the writing was on the wall: Facebook was going to answer Yahoo’s suit with a lawsuit of its own.
Every time a patent holder thinks about filing a patent lawsuit, the first question to ask is whether the intended target will be able to retaliate. Retaliation might be based on patents that the target already owns. When Nokia sued Apple, for instance, Apple quickly dusted off some patents from its archive and sued back. But, as the Facebook example makes clear, the market for intellectual property is today sufficiently liquid that retaliation can easily be based on patents newly acquired solely for that purpose.
Retaliatory litigation is a particularly significant challenge for patent holders that generate substantial revenue of their own. Microsoft, for instance, is very vulnerable to retaliatory litigation. It has so many products, and so much revenue, that an accused infringer will have no trouble finding a patent in the marketplace that (a) Microsoft plausibly infringes; and (b) would, if infringed, be worth a substantial amount of money in court.
By the same token, retaliatory litigation is not a viable strategy in instances where the patent holder’s only significant business involves patent litigation and licensing. Bluntly, there is no point in suing a patent-holding company like InterDigital, Intellectual Ventures, or Acacia for patent infringement. None of those entities generates more than trivial revenue from the sale of actual products or services, and hence there would be no cash damages to pursue in a litigation effort.
One ironic implication here is that bankruptcy sometimes serves to increase patent value, because bankruptcy can in essence transform a company that makes products into a company that simply licenses patents. When memory chip manufacturer Elpida was actively selling its DRAM memory in the market, for example, Elpida’s patents were of little value. Had Elpida filed suit against a rival like Hynix or Samsung, those firms would have responded by bringing their own patents to bear against Elpida. Once Elpida declared bankruptcy, however, the analysis changed. If its patents are sold as a stand-alone asset, or if the company ends up shutting down its manufacturing capabilities and emerging from bankruptcy simply as a patent licensing entity, the risk of retaliation will be fully eliminated. Patents that were previously constrained by mutual assured destruction will all of a sudden be available for aggressive enforcement.
Managing the Risk
Firms vulnerable to retaliatory litigation have endeavored to mitigate that risk through different types of transactions and structures, but it is not clear that any of these tricks in fact works. Micron, for example, is another memory chip manufacturer with a large and valuable patent portfolio. Like Elpida, it, too, was unable to aggressively license its patents for fear that its licensing targets would respond with retaliatory suits. So Micron transferred its patent portfolio to two different stand-alone patent licensing entities: Round Rock, a company explicitly established for the purpose of receiving and then monetizing the Micron patents; and Mosaid, which at the time was already managing a related, existing patent portfolio. Micron then stood back while those two entities enforced the patents. To date, those enforcement efforts are rumored to have generated hundreds of millions of dollars, and yet the firms targeted by those enforcement efforts have not retaliated against Micron. This is striking but possibly only temporary. After all, each target is well aware that the patents being enforced by Round Rock and Mosaid belonged to Micron.
Retaliation is not merely a risk faced by patent holders; it is also an important strategic consideration for potential infringers. Amazon, for instance, is newly an important player in the market for portable wireless electronics, thanks to the very successful launch of its Kindle Fire hardware. Amazon is thus now a target for potential litigation from firms like Apple, Samsung, and Nokia, each of which not only holds patents relevant to the Kindle Fire, but also surely feels threatened by Amazon’s new-found success. How should Amazon prepare? While one strategy would be to study its rivals’ patents and endeavor to avoid potentially infringing technologies – a Herculean and likely impossible task – the more practical approach would be for Amazon to amass a relevant patent portfolio of its own. Those patents would cause rivals to pause before starting a scuffle, knowing that their revenues will also be on the line in the event a patent war breaks out.
The implications of all this are messy. Because of retaliation, patents are not being evaluated in isolation, but are instead being horse-traded and cancelled out in complicated, multi-patent transactions. That creates a real risk that patents will be mispriced in the market; and that, in turn, might confuse and/or dampen the incentives that patent law was designed to create.
Put differently, the patent system likely works in situations where a single patent meaningfully maps to a single technology, and that single technology is in turn fully and exclusively embodied in a single product or service. But, thanks to retaliation strategies (as well as other considerations, like the rise of large, overlapping patent portfolios) modern patent transactions almost never look anything like that. That makes me nervous. In my view, as more patents become relevant to any transaction, the less likely it is that the resulting deal will correlate accurately with the underlying inventive realities.