Extended version: The global IP battlefield

The stakes are higher than ever in international IP disputes

The metaphors people use to describe intellectual property disputes are a lot more martial than they used to be. But then, the stakes are higher than ever. As industries grow steadily more sophisticated about the way they manage and defend their innovations, the consequences for missteps expand proportionally. With less and less margin for error, companies are increasingly willing to do battle over their most critical IP.

“A couple years ago, we were fending off trolls, but now it seems like we’re doing global warfare for competitors,” says Brian Busey, an IP litigator at Morrison Foerster. “Trolls haven’t gone away, but now at the same time companies have to manage larger litigation involving competitors, and it’s gone global. A lot of in-house counsel are flying all over the world, managing cases from Germany to Seoul.”

Nowhere are these global IP battles more intense and expensive than in areas of emerging technology—such as smartphones, tablet devices and LED lighting—where well-heeled tech giants are pulling no punches in their ambition to establish market dominance for years to come.

“2011 was the year in which intellectual property issues in the mobile devices industry came to the forefront,” says Horacio Gutierrez, deputy general counsel for the IP group at Microsoft Corp. “Most of the activity we observed—from litigation to acquisitions to licensing deals—were responses to the fact that disruptive technologies came to the market with key IP issues unsettled.”

That uncertainty drove a blockbuster year for IP deals. In June, a consortium including Apple Inc., Microsoft, Ericsson, Sony and Research In Motion Ltd. ponied up $4.5 billion to acquire 6,000 patents from the bankrupt Canadian company Nortel Networks Corp. It was the most ever paid for a pool of patents. Google Inc., which was outbid in the auction, responded by paying $12.5 billion to acquire struggling Motorola Mobility Inc., largely for its patent portfolio.

Such astronomical price tags were inflated by the strategic value of patents in the smartphone wars.

“Mobile computing is a whole new frontier,” says one tech-sector in-house IP counsel. “That’s what drove those insane prices in the auctions. It’s not a change in the value of IP. Companies like Microsoft, Google and Apple all want things they think the other ones have or are afraid someone else has a head start. I think you have very huge egos showing each other how serious they are, that there’s nothing they won’t do to win this fight. Put people like that in an auction situation and crazy things happen.”

But while such megadeals may be limited to the tech giants, the pressure to monetize patents is not. Splashy coverage of huge portfolio auctions only stokes the growing pressure on in-house counsel to leverage their intellectual assets any way they can.

“Each of these deals affects everyone who depends upon IP,” says Bruce Schelkopf, deputy general counsel and chief IP counsel at Ingersoll Rand. “They’re great teaching tools. They help educate the C-level folks on the value of patents and on what’s happening in the marketplace. They also are bringing the burgeoning IP patent market out from behind closed doors.”

If 2011 had ended with the Motorola deal, it would have been a banner year in the IP annals, but of course it didn’t. September brought the Leahy-Smith America Invents Act, the most sweeping reform of the nation’s IP system in six decades. The new law addresses many longstanding problems and will significantly reshape the ways companies manage their IP.

“We’re headed into a new strategic paradigm where the U.S. Patent and Trademark Office (USPTO) pays a greater role in resolving patent issues,” says Michael Bednarek, an IP partner at Axinn Veltrop & Harkrider, “but it will take years, if not decades, to sort through what it means in terms of strategy.”

Battlefield Earth

Today’s IP litigation knows no borders.

On May 2, 2011, Huawei Technologies Inc. won a trademark case against its biggest competitor, ZTE Corp. It was a minor squabble on the fringes of the global smartphone wars—a massive tangle of ongoing litigation involving hundreds of companies, thousands of patents, and the future of the burgeoning mobile computing market.

Huawei, a mammoth phone-equipment maker with a hard-charging reputation, won an injunction that stopped upstart rival ZTE from using its mark on memory devices. The case would be a minor footnote if not for one fact: Both Huawei and ZTE are based in Shenzhen, China. The ruling came in a fast-track proceeding in Hamburg, Germany.

“Chinese companies are getting savvy very quickly on the best venues to fight these patent and trademark issues,” says Sharon Barner, a partner at Foley & Lardner.

For large companies, IP enforcement has always been an international effort, but litigation traditionally was focused on stopping infringement in a particular jurisdiction. Now, the most aggressive companies are cherry-picking venues that are fast, cheap and patent friendly as they maneuver on multiple fronts in what has truly become a global battlefield.

Germany is at the top of the list. There’s not as much discovery as in the U.S., but litigation there is comparatively inexpensive, the bench is highly sophisticated, damages are substantial and the process moves quickly. IP action is heating up elsewhere as well, including in Japan, Korea, China, Australia and Spain.

“It’s just a whole new level of intensity, and global players are looking for forums where they can put pressure on,” Busey says. “In-house counsel are being stretched to understand how these different forums globally interrelate, in terms of speed and outcome. It’s certainly interesting—and costly.”

Busey’s practice focuses on actions at the International Trade Commission (ITC), yet another front in the emerging technology battles.

“When I started doing ITC litigation in the late ’80s, the ITC had maybe 10 or 12 cases a year,” he says. “There were 69 new investigations through the end of [the 2011] federal fiscal year, which is an all-time record. There’s something like 100 active matters and there are trials every week. These are mostly big cases, lots of them involving smartphones, LEDs and GPS technology.”

These high-tech battles may be setting the tone for IP litigation around the world and establishing tactics that will ripple through corporate practice for years to come, but they won’t last forever.

“There were patent wars in the past and they always come down to who gets into the position to strike a crippling blow first,” says Paul Roeder, associate general counsel for IP litigation and public policy at Hewlett-Packard Corp.

Speed and decisiveness are critical, so when the combatants have the financial wherewithal, they file every case they can, and employ every novel tactic they can think of to gain the advantage. In the smartphone wars, that dynamic has taken many forms. Samsung filed a case in Australia—something of an IP litigation backwater—this past September. Apple has asserted design patents with gusto—a rarity in patent litigation.

“People are looking for every gun, bomb or pointed stick they can find to hit each other,” Roeder says. “When those things shake out—and they will shake out—you’ll go back to seeing a fairly low level of IP litigation globally. Ultimately IP litigation in the U.S. will go back to where it was in the ’90s.”

For the moment, tempers are high, no holds are barred and no expense spared. Sooner or later, however, companies will start crying uncle, and the focus will shift from litigation to cross-licensing.

“There’s enough good market out there for most of these companies to continue to exist and do well,” Barner says. “And that’s what you ultimately find in many industries—everybody finds a way to make peace and coexist.”

Unpacking the AIA

Tomorrow’s IP battles will be fought at the USPTO.

It was a long time coming. After decades of mounting consternation over the U.S. intellectual property system, President Obama signed the America Invents Act (AIA) into law on Sept.16, 2011. It’s the most comprehensive patent reform since 1952.

The AIA shifts the U.S. from a first-to-invent to a first-to-file standard. The law harmonizes the U.S. system with Europe and other foreign jurisdictions, and should make the process of prosecuting, challenging and defending patents faster and cheaper—but it won’t happen overnight.

“Most of it will not come into effect for a while,” says Barner, who served as deputy under secretary of commerce for intellectual property and deputy director of the USPTO from 2009 to 2011. “We have 1.2 million patents pending right now, and any patents filed before March 16, 2013, do not fall under the new system. It could take five or 10 years before everything really falls into place.”

The law itself will take effect in several stages throughout the next two years, but it will take several more years for the system to mature as the first patents issued under the new regime wend their way through disputes.

Some provisions, such as new joinder limitations and new inter partes re-examination standards, were implemented the day the law was signed. A fee-based fast-track examination process came online 10 days later. A transitional post-grant review procedure for business method patents and a supplemental review that will help patent owners improve the quality of existing patents will kick in on Sept. 16. The most significant aspects of the new law, however, won’t be active until March or September 2013.

The AIA is a collection of so many new initiatives and tweaks to existing programs that sweeping generalizations are difficult, but a theme that runs through many of the law’s provisions is one of openness and collaboration with the patent system’s many stakeholders throughout the patent life cycle.

Up to now, the patent office acted more or less on its own in granting patents, and those that it issued were presumed valid. The elephant in the room was the fact that the patent office has nowhere near the resources required to look at everything that could affect validity. Large numbers of invalid patents made it into the marketplace, inevitably leading companies to fight it out in court.

“When this act is totally implemented, you’ll see the patent office issuing higher quality patents,” says Bednarek, a former patent examiner who maintains an intimate familiarity with PTO procedures. “Under the AIA, they’re increasingly able to partner with stakeholders, take outside submissions, allow the patent holders themselves to clean up problems that occur through supplemental examination, and then provide a forum—through post-grant review or inter partes review—where people can very quickly receive a high-level review.”

Post-grant review will allow third parties to challenge the validity of a new patent within the first nine months after it is issued. This gives companies a powerful tool, provided they are organized and on their toes. They have to keep tabs on their competitors’ filings and be prepared to act fast.

After that nine-month window, third parties can request an inter partes review, albeit under a tougher standard. The AIA raises the inter partes bar from “a substantial new question of patentability” to “a reasonable likelihood that the requestor will prevail,” which should filter out many borderline challenges.

In either process, the matter is reviewed at the highest level of the patent office and usually resolved within a year. That’s a fraction of the time litigation takes, but the onus is on companies to step into the process.

“In the past it was probably sound practice to effectively put your head in the sand and wait until you were sued because you didn’t want to be accused of having knowledge of a patent and being a willful infringer,” Bednarek says. “Even if you became aware of someone else’s patent application, there was little you could do to stop it. That is changing in a dramatic way because of the AIA. The lesson for companies is to be more proactive.”

Once the AIA is fully up and running, most patent disputes will be won or lost at the USPTO, not in the courts. In the meantime, however, the most immediate impact of the law will be felt by those most pernicious of patent litigators: trolls.

The nonpracticing entity (NPE) business model is all about volume. Sue a lot of people in a favorable venue and bet that they’ll pay up to avoid the cost and hassle of litigation. Different jurisdictions have interpreted joinder rules, which let plaintiffs sue many defendants at once, in various ways. In the notoriously troll-friendly Eastern District of Texas, courts have held that asserting the same patent against multiple parties is sufficient connection to justify joinder. Some cases have had more than 100 defendants. No more.

“Under the AIA, Congress has made explicit that you don’t automatically join multiple defendants together just because their products, although distinct, are alleged to infringe the same patents,” says Hank Gutman, head of the IP practice at Simpson Thacher. “That will be a big help in these joint defense cases. It’s very difficult to run them on an efficient, cost-effective basis. Typically, you have 12 different law firms representing 12 different clients all discussing how to respond to a discovery demand or a nasty letter. You can imagine how much more expensive it is.”

Plaintiffs can still file separate cases and then ask for consolidation through discovery, but if they’re forced to go to trial against each individual defendant, the cost leverage will be reversed. Plaintiffs will be much less likely to pursue marginal or spurious infringement claims because it would force them to spend real money in the process. That could mean a significant reduction in NPE litigation over the long term.

Selling Arms

Many counsel are under pressure to monetize patents.

There was a time when companies used intellectual property to protect their innovations and defend their products in the marketplace. Then along came companies that don’t have products, but have patents and make a living suing on them. That led to the formation of other companies that aggregate IP for “purely” defensive purposes. This all stoked a market where various combinations of strange bedfellows trade patents like so many chits in a game that has less and less to do with the innovations they were secured to protect in the first place.

Add to the mix a few dozen of the world’s biggest and richest companies locked in pitched battles over their coolest gadgets. They spend billions of dollars gobbling up every patent they can find to assert in a seemingly infinite chain of claims, counter claims and counter-counter-claims. Those megadeals end up on the news crawl on the CFO’s office TV. So the CFO marches down the hall, knocks on the general counsel’s door and says, “Hey, we’ve got a bunch of patents, right? Where’s our billion-dollar deal, hmmm?”

A gross oversimplification? Probably. The point is that a complex series of trends have converged to put the pressure on in-house counsel to monetize patents. Some jump at the chance, eager to partner with the business side and be less of a cost center. Others just wish things would settle down and go back to the way they were. Either way, the monetization imperative is real and it’s growing.

“There’s not a client with a sizable portfolio who isn’t approached by people, financial types, with great ideas for how to convert their patents into cash and who aren’t being asked by management, ‘OK, you’ve got X-thousand patents, what are you doing to exploit them?’” Gutman says. “Unless you want to go be a troll, you have to find some other arrangement.”

Options abound. As the pressure to monetize patents has mounted, a whole industry has sprung up to help companies sell, manage or pool their IP. The number of alternative structures available is growing at an astounding rate.

Companies can auction off patents individually or in bundles. They can farm out their assets to licensing shops that try to generate royalty streams. They can sell to defensive aggregators that pool vast numbers of patents to counterassert against trolls, or bite the bullet and sell to the trolls themselves. There’s no clear-cut right answer. A lot of how a company chooses to monetize its portfolio is driven by its size, internal capacities and level of financial necessity.

“You’ll see more of these companies selling their portfolios to other entities that have more expertise in the licensing area,” says Alan Grimaldi, who leads the IP practice at Mayer Brown. “They’re spending all this money on R&D but not getting a licensing return. Now they can license the portfolio to some other company and reap the rewards without the investment. That seems to be what’s trending. You’ve seen a lot of those big deals in the news over the past year.”

Sometimes, however, the deal is too good to be true. Somewhere behind the drive to monetize patents is the unspoken reality that, in a sense, companies are trying to unload an asset or operation that they can’t afford to fully realize or don’t fully understand. And that can be a recipe for ending up with the short straw.

Until fairly recently the bulk of a company’s value was attributed to tangible assets. Now the reverse is true. According to Michael Gollin, a patent lawyer who chairs the life sciences practice at Venable, 50 percent to 80 percent of corporate value is now intangibles, and the track record for their valuation is spotty.

“Companies do a tolerable job of looking at the expenses associated with IP, but no one wants to spend more money than they have to—they want to minimize costs,” he says. “So you have a fair amount of attention on the asset side and on the expense side, but that’s sort of a lopsided view because you need to look at assets and liabilities together under basic accounting principles, and you need to look at income and expenses together.”

Moreover, blockbuster portfolio deals driven more by global litigation strategy than actual asset value only contribute to a skewed, overly rosy outlook. Eastman Kodak Co., for example, got a wakeup call when it tried to auction a 1,100-patent bundle this past August. Some sale projections topped $3 billion, but the bidding war never materialized. The auction is still on hold as the company struggles to avoid bankruptcy.

In an environment where so many new entities are banging at corporate doors, asking to take over the portfolio, companies have to be skeptical. As patents have become more liquid, they’ve grown more volatile. The new third parties in the market are morphing as they grow, making committing to them a somewhat dicey proposition.

“When you get in bed with people who assert patents, you’ll find it very difficult to get the money that they promised you,” says HP’s Roeder. “All it does is just whip up more and more patent litigation. That pressures other people to do the same thing, and it just feeds the problem. We all lose when that happens.”

Roeder says he sympathizes with counsel who have little option but to sell their patents, knowing full well that others will immediately be sued on them. Their companies may be facing their own litigation problems or struggling to right the balance sheet. Still, he sees it as feeding the NPE menace.

“It’s just so annoying, hurtful and frustrating,” he says. “On one hand, people talk about trying to solve the problem, and on the other hand they say, ‘If you can’t beat them, join them.’ You can beat them. We can beat them. But it gets harder every time you sell to them. You’re actually slowing down the effort to beat them when you do that. And these giant patent sales are having a very negative impact on trying to rationalize damages in patent litigation.”

But there is light at the end of the tunnel. Roeder is hopeful that new damages rules, improvements to the patent system that the AIA offers and especially the new joinder provisions will quell both the NPE phenomenon and the pressure to monetize.

“This will die down, and the pressure on companies that previously didn’t really think about monetizing their IP will fade,” he says. 

 

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