Prof. Robert P. Merges, University of California at Berkeley School of Law
July 22, 2013

Talk of trolls and patent reform is in the air.  Many speak of a crisis, a sense that the center of the patent system is not holding.  Reforms span a wide spectrum: While the Supreme Court reins in what it sees as overbroad, anti-innovative patents, Congress (through the AIA) gives patent challengers more ways to kill issued patents without going to court.  Some push to go much further, with Vermont passing an anti-troll law at the state level and a number of targeted anti-troll measures slowly working their way through Congress.

It is tempting to get caught up in the details of these proposals.  Some ideas seem good, some bad.  The action here is most definitely in the details; fixing the problems of the patent system requires careful attention to the harms identified and the particular fixes proposed.

But I want to emphasize a different point here.  I want to look at the litigation problem in its larger context, to ask how litigation fits into innovation policy, defined as the overall set of rules, practices and institutions whose goal is to foster new technology.  My idea is simple, but I hope useful: to bring attention back to the purpose of patent litigation – its place in the overall scheme of innovation policy.  From this point, I make two observations.  First, recalling the purpose of litigation may help guide patent reform efforts; remembering what litigation is supposed to do may help us fashion rules to restore its primary function.  Second, and perhaps more radically, recalling the goal of litigation may suggest ideas about how to achieve this goal in other ways.  It may, in other words, open the door to reimagining an innovation policy that relies far less on litigation, or even not at all.

Innovation policy is about encouraging meritorious new technologies.  Patent law fits in this way: Society awards property rights to inventors, as a means of encouraging research and promoting innovation.  Property in this scheme has a dual aspect, uniting both public and private.  A public agency examines and then grants patents.  But once granted, a patent is a private right over a discrete asset, held by an individual owner.  How the right is used post-grant is entirely up to the rightholder.  The only public role comes at the enforcement stage, when society at large provides courts to hear patent cases.

From society’s point of view, patent enforcement is part of the system that encourages innovation.  But of course, litigation is costly.  A long tradition in Anglo-American law treats it as a sort of necessary evil.  It is essential, sometimes, but never viewed as a positive end in itself.  From a certain point of view, it might be said that the optimal litigation rate is zero.  Certainly it is a goal of the legal system to delineate rights so clearly that parties bargaining over legal issues will quickly converge on a settlement.  But in the real world such consensus is unlikely.  Because parties bargaining over legal issues will sometimes arrive at different valuations of their legal rights, irresolvable disputes are inevitable.  So courts are a necessary adjunct to a system of predominantly private rightholding and bargaining.

Litigation is therefore a classic example of a transaction cost: a necessary expense in the moving of goods, services, and legal rights from one person to another.  When the filing of lawsuits is kept at a manageable level, it is an acceptable cost of doing business.  But when suit-filing becomes a red-hot growth industry, an end in itself, trouble is afoot.  As a way of resolving disputes over the transfer of assets or legal rights, litigation makes sense.  As the basis of productive economic activity, not so much.

Take tort litigation, for example.  The idea behind tort law is to compensate victims who have been subjected to unreasonable harms.  Because the valuation of tort claims is an inexact science, negotiated agreements over compensation will break down in some nontrivial number of cases.  And so, tort litigation.  For many years, this was an accepted part of the world of injuries, compensation, and insurance.  But when, as a the result of various changes in the law and practice of torts, litigation began to mushroom in the 1970s and 1980s, there was a widespread perception that the “personal injury” lawsuit business had gotten out of hand.  Tort reform, which took (and takes) many forms, was the inevitable result as companies that made things and performed services were confronted with ever-growing legal bills due to the massive growth in tort litigation.

There is another dimension to tort litigation that also seems important for the case of patents.  It must be said that the smooth functioning of society depends to a certain extent on the underenforcement of formal rights.  If every time someone bumped you, you filed suit for battery, we would all spend much of our time in court.  For tort litigation to not get out of hand, we must rely on people not to insist on the full enforcement of every formal right they hold.

The same is true for patent litigation.  This was always understood in a vague sort of way; with literally millions of patents in force at any given time, and many of these with multiple claims covering distinct variants of each invention, the world has always been awash with a profusion of formal patent rights.  Actual litigation, however, stayed at a manageable level.  This was partly due to the fact that hardheaded business people estimated that in many cases the cost of patent enforcement was a net-negative proposition.  But there was another cause as well: the widely shared belief that patent litigation was exceptional, a rare event in the life of a company or individual.  Many cases of technical infringement were overlooked or ignored.  Only when the stakes were high, or perhaps when personal feelings were involved, did people of commerce resort to litigation.

Now this is changing.  Patent litigation is on the increase.  The troll business model is the main driver.  But large corporate patentees are contributing as well.  This is an inevitable outgrowth of increased attention to the profit-related potential of patents.  What began as a movement to discover “Rembrandts in the Attic” – valuable assets that were being under-utilized – led in turn to more aggressive patent exploitation programs.  Hence more litigation.  There is an irony of sorts to this.  Each company is encouraged to discover unused assets and exploit them.  But other companies are doing the same thing.  When someone else’s “Rembrandt” leads to a licensing demand, the revenue you gain from exploiting your own Rembrandt may be paid straight to other patent owners.  Some companies, those with more valuable assets, will be net gainers.  But many others will only break even, or find themselves in the red.  The situation may turn out like the old economics joke about the town where people tried to survive by taking in each other’s laundry.

Even a company that holds enough patent “Rembrandts” to come out ahead in the licensing game may end up making far less money than anticipated.  The reason once again is the transaction costs of litigation.  In the worst-case scenario, most of the gains from exploiting underused patents may wind up in the hands of patent litigators.

Looking to Torts Again: Keeping in Mind the Idea of an “Innovation System”

Tort scholars recognized long ago two crucial facts about tort litigation: First, it is a means to an end, a necessary component of an overall approach to compensating victims of harm; and second, if this component becomes too costly, then alternative mechanisms for compensating harms begin to look far more appealing.  Again, the point is that there is nothing inevitable about the need for tort litigation.  If it makes sense as part of a compensation system, it should be retained.  If not, then society ought to dispense with it.

In tort law, the usual alternatives involve either some system of strict liability for harm, which dispenses with the complex and litigation-rich issues of proving fault; or a system of social insurance that pays accident victims out of a general insurance fund, much like, say, unemployment insurance.1  Each of these alternatives involves significant costs.  And tort scholars point out that even apart from costs, there are persuasive arguments against them – particularly centering on the ethical importance of assigning fault and the moral appeal of making negligent people pay for the consequences of their actions.2  Yet as strong as these arguments are, when tort litigation gets out of hand, alternative systems of victim compensation come back into the policy conversation with a vengeance.

Something similar comes to mind when confronted with the rise in patent litigation.  Because patents have been awarded to inventors for several centuries, we have become accustomed to our decentralized system of innovation promotion through the grant of individual ownership rights.  But there is nothing inevitable about this.  There are alternative systems of innovation promotion, some of which have been the subject of intense interest in recent years.  If patent litigation cannot be brought under control, these alternatives are soon going to become much more appealing.  Thus those who believe in a property-based system of innovation promotion – and I count myself among them – ought to take an acute interest in the topic of litigation reform.  It may be the key to preserving the benefits of our traditional patent system as a means of promoting innovation.

So for example, one beneficial feature of the patent system is that it rewards successful outputs from the R&D process.  The most valuable patents cover inventions that are embodied in real products and sold on the market.  Other instruments of innovation policy, such as government-subsidized research and R&D tax credits, reward inputs instead.3  A grant is paid before results are achieved; a tax credit is available for R&D expenses whether they are connected to a successful project or not.  Only patents disproportionately reward the success stories of the R&D world.

But the positive case for patents breaks down when litigation costs exceed a certain threshold.  At some point the patent game is no longer worth the candle.  This is where alternative policies may start to become more appealing, and at some point, actually preferable to an innovation regime centered around patents.  Unless the transaction costs of awarding patents are kept manageable, the award of patent rights no longer has a comparative advantage over other mechanisms of innovation policy.

Conclusion: Common-Sense Steps Forward

In light of all this, we need to do two things.  First, continue to study the impact of the recent surge in patent litigation.  So far we have just documented the bare facts.  We need more and deeper studies of what this new wave of litigation is doing to R&D and innovation.

Second, we need to be developing tools to eliminate the low-hanging fruit – the obviously useless litigation.  Pure nuisance suits, those where the cost of a lawsuit is clearly higher than the intrinsic value of the underlying technology and patent, are a good first target.  Recent proposals to widen the scope of attorney sanctions for bringing frivolous litigation represent a good first step.  More shifting of attorney fees – a more aggressive use of British rule-style litigation costs – also makes sense.  Meanwhile we should explore some of the more far-reaching proposals to restructure discovery, bifurcate trials, encourage quick summary judgment, etc.

My simple point is that if we do not pursue these options aggressively, there is a risk that the basic logic of a decentralized innovation system may begin to break down.  As a fan of that system, I find that a troubling prospect.