The recipe for swinging the pendulum of patent law towards weaker patent rights is simple: Start with a generous warning about the scourge of low quality patents, stir in a skosh of fear mongering regarding non-practicing entities (NPEs) asserting those patents, then apply heat with predictions of lost jobs and threats to innovation, publicize in a blog, speech or article, and there you have it!

Hyperbole aside, the long accepted nexus between NPEs and “low quality patents” rests on the notion that, true to their name, NPEs purchase patents without the intent to practice them in products. Grace Heinecke, “Pay the Troll Toll: The Patent Troll Model is Fundamentally at Odds with the Patent System’s Goals of Innovation and Competition,” 1171. Instead of aiming to use their patents in the traditional sense, NPEs—specifically the subset of NPEs pejoratively referred to as “patent trolls”—acquire patents to assert them against parties practicing those patents, to extract licensing fees or settlement payments, which the practicing entities choose to pay to avoid the cost of litigating an infringement suit. Id. at 1171-72; John F. Luman III & Christopher L. Dodson, “No Longer a Myth, the Emergence of Patent Troll: Stifling Innovation, Increasing Litigation, and Extorting Billions.” (This article will treat the terms “non-practicing entity,” “patent troll,” “patent assertion entity” and “patent monetization entity” as equivalents.) Since low quality patents yield unpredictable litigation outcomes, so the accepted wisdom goes, they are “excellent fodder” for NPEs, who leverage this uncertainty to induce settlements from alleged infringers. Luman & Dodson, supra.

This narrative has become pervasive. Writing in 2011-2012, advocates for this view warned that “[NPE lawsuits harm] society. While the lawsuits increase incentives to acquire vague, overreaching patents, they decrease incentives for real innovation overall.” James Bessen, Jennifer Ford & Michael Meurer, “Do Nonpracticing Entities Benefit Society by Facilitating Markets for Technology?” Such warnings led to action, and have propelled recent IP policy making. Comments made on the floor of the US Senate in 2014 understandably reflected the belief that NPEs actually depend on low quality patents: “[l]ow quality patents are essential to a patent troll’s business model.” 160 Cong. Rec. S6124 (daily ed. Nov. 19, 2014). Even strong patent advocates have pointed to low quality patents asserted by patent trolls as the problem with the patent system. Just last year, a strong-patents scholar described the patents acquired by trolls as “dubious, highly questionable patents that in many cases should never have been issued,” that are “low quality” and “overbroad.” Gene Quinn, “The PTAB has Failed to Solve the Patent Troll Problem Created by Large Operating Companies.”

Perception

Linking NPEs and low quality patents has provided an apparent two-for-one solution. Weakening patent rights will weed out the low quality patents held by NPEs while, presumably, the high quality patents held by “real innovators” will not be affected. Much of our patent policy and jurisprudence over the last decade reflects this line of reasoning. But what if the reasoning in support of all these changes is wrong? What if NPEs don’t depend on low quality patents at all? And what if weakening patent rights hurts real innovators? Factually, this has become, and is now the case.

The America Invents Act (AIA) became law in 2011, ushering in the age of inter partes review and covered business method proceedings. These inexpensive, quick administrative processes have proven attractive to accused infringers, invalidating patents at notable rates. See Brian J. Love & Shawn Ambwani, “Inter Partes Review: An Early Look at the Numbers” (“Compared to requests for inter partes reexamination, petitions for IPR are currently granted at a similar rate, but once instituted, they result in the elimination of every challenged claim about twice as often[.]”). The Supreme Court’s Alice v. CLS Bank decision in 2014 led to patents in the business, software and pharmaceutical areas being more commonly found per se ineligible for patent protection—while there were just two patents invalidated due to unpatentable subject matter in the first quarter of 2014 (before Alice), this number rose to 49 in the first quarter of 2015 (after Alice), 50 in the first quarter of 2016 and 104 in the first quarter of 2017. Robert R. Sachs, Bilskiblog.com; Lex Machina. (While there was not a consistent increase in the number of patents invalidated due to unpatentable subject matter in each quarter between 2014 and 2017, this figure was consistently above 20 from the third quarter of 2014 through the third quarter of 2017.) Underpinning these changes was the presumptive notion that NPEs live off low quality patents. In a Congressional Record statement leading up to the passage of the AIA, it was noted that “[p]atents of low quality and dubious validity … enable patent trolls who extort unreasonable licensing fees from legitimate businesses, and constitute a drag on innovation.” 157 Cong. Rec. S936-53. Even after the AIA was passed, the Supreme Court highlighted trolls in discussing the purpose of IPR:

there are these things … let’s call them patent trolls[.] … [T]he Patent Office has been issuing billions of patents that shouldn’t have been issued … . [W]hat we’re trying to do with this process is tell the Office you’ve been doing too much too fast. Go back and let people who are hurt by this come in and get rid of those patents that shouldn’t have been issued.

(This statement was made by Justice Breyer during oral arguments in Cuozzo Speed Technologies v. Lee. See Stuart Duncan Smith, “IPR Gets its Day at the High Court”; Ronald Mann, “Argument Analysis: Justices Struggle to Read ‘Tea Leaves’ in Congress’s Slipshod Drafting of Patent Act Provisions for Inter Partes Review.”)

Our nation’s patent policies over the last generation have largely revolved around making the NPE business model unprofitable. But why then are many NPEs still in business years after the fact?

Have NPEs figured out how to make their business models work with “low quality patents” even as patent rights have been weakened? NPEs today are getting most of their patents from large operating companies. See James Kovacs & Nader Mousavi, “Why Smart Corporate IP Strategies Need License on Transfer.” Some commentators insist that these large companies are selling their low quality patents to NPEs to make quick cash. Quinn, supra; Erik Oliver, Kent Richardson & Fredrik Johnasson, “When do Operating Companies Sell Their Patents?” (“We found a significant indication that companies who sold patents to NPEs were in financial distress at the point of sale.”). This argument seems predicated on the belief that NPEs have found a way to continue making money on these low quality patents in a weakened patent rights environment. Otherwise, why would they buy such low quality patents? The premise seems implausible given the current regime of enhanced mechanisms for invalidating patents.

Reality

To be sure, low quality patents and their role in fueling abusive litigation were a problem in the era leading up to the AIA. Congress and the courts were correct in identifying patent quality as a priority to discourage abuse, and in putting measures in place to raise the bar on patent quality, provide the USPTO and courts with tools to improve and police quality, and discourage those who are prone to abusing our country’s flexible legal system from using the patent system to do it. The question we face now, and the focus of this article, is on what has occurred post-AIA—the signs that we have unnecessarily weakened our patent system based on what is now a false premise, and the unexpected consequences of creating a policy obsession with patent trolls that has lasted long after suppression of the problematic behavior.

While the continued weakening of the patent system may have beaten the dead horse of so-called “ankle-biter trolls” that counted on the cost of litigation to leverage low quality patents, its most prevalent impact has been to promote efficient infringement. See Eduardo Porter, “Patent ‘Trolls’ Recede as Threat to Innovation. Will Justices Change That?” New York Times, Nov. 21, 2017 (describing the AIA’s effect on patent trolls); Ryan Davis, “Fed. Circ. Affirms PTAB Ax of MPHJ Scanner Patent,” Law360, Feb. 13, 2017 (highlighting the 2017 invalidation of a patent belonging to MPHJ Technology Investments, “a company that became notorious for asserting its patents against thousands of small businesses” via “demand-letter abuse”); “A.G. Schneiderman Announces Groundbreaking Settlement with Abusive ‘Patent Troll’” (noting, in a 2014 press release, that a type of “strategy” employed by MPHJ “can be successful … because smaller businesses often do not have the experience or resources needed to fully evaluate the [asserted] patents”). As we explained in “From Efficient Licensing to Efficient Infringement,” the weakening of our patent laws has ushered in a regime where patent infringers now have the economic incentive to ignore allegations of infringement regardless of the quality of the asserted patents. In this environment, innovative operating companies can no longer rely on voluntary licenses from competitors using their patented innovations as a means to recoup the innovator’s R&D investment, as infringing competitors are better off simply infringing and risking litigation, versus paying for licenses voluntarily. David Kappos, Richard Ludwin and Marc Ehrlich, “From Efficient Licensing to Efficient Infringement,” New York Law Journal, April 4, 2016; Joe Nocera, “The Patent Troll Smokescreen,” New York Times, Oct. 23, 2015. In the technology industry many companies now regularly engage in this efficient infringement behavior—to the point where a former White House official actually endorsed the approach in a Wall Street Journal op-ed. Colleen Chien, “The Best Way to Fight a Patent Demand May Be to Do Nothing,” Wall Street Journal, Nov. 23, 2015.

Confronted with this new reality, inventive operating companies understandably seek ways to overcome the inertia of efficient infringement, and increasingly it appears they are deciding to transfer some of their highest quality and most licensable patents to NPEs who are capable of running the serial enforcement and litigation programs necessary to break the resistance of efficient infringers. Successful operating companies such as Panasonic, Ericsson and Dongbu HiTek, among others, have transferred patents to NPEs in the last five years. Jack Ellis, “Conversant Reaps Ethical Licensing Reward in Bounce-Back Panasonic Acquisition”; Richard Lloyd, “Unwired Planet to Sell Patent Business for $30 Million; Buyer Increases its Stockpile of Ericsson Assets”; Jack Ellis, “Conversant Picks Up Patents From Top Korean Vendor.” This trend is a straightforward division of labor application. Operating companies focused on innovation are hard-pressed to engage in multiple litigations with recalcitrant licensees whereas NPEs are purpose-built for this environment.

So, it appears the policy of weakening patent rights to starve NPEs of low quality patents has instead caused some of the most prolifically innovative companies to transfer their best patents to these very same NPEs—which are built to withstand the efficient infringement model. With NPEs now acquiring crown jewel patents from innovative operating companies, one would think those parties originally advancing policies to weaken patent rights would reconsider. Upon witnessing the increasing number of operating companies whose best patents are finding their way to NPEs, one would think these voices would be telling Congress and the courts to call off the pattern of patent-weakening actions because it is having the effect of bolstering the NPEs. But where are those calls? It seems they are nowhere to be found. Why?

It is now apparent that much of the continued criticism of NPEs is not about NPEs. The NPE narrative is merely effective cover to weaken patent rights across the board. As we discuss below, the fact that the weakened patent environment has been a boon to NPEs should come as no surprise to those knowledgeable about the patent licensing business and business economics.

Taking an Economic-Based View of NPEs

If policy makers and the innovation community generally misunderstood the role of NPEs, where does this leave us with fixing our patent system? And do we need to further address NPEs?

Stripped of the rhetoric, NPEs are simply investors. And as investors they act in economically predictable ways. Just like stock market investors, they buy when they believe the purchase price is less than the intrinsic value of an asset. From the late 1990s to the early 2000s, NPEs bought patent assets, many of arguably questionable legal quality, on the cheap from financially distressed internet companies in a strong patent law environment. Colleen V. Chien, “Of Trolls, Davids, Goliaths, and Kings: Narratives and Evidence in the Litigation of High-Tech Patents,” 1580; James M. Rice, “The Defensive Patent Playbook,” 737; Sarah Hasford, “America Invents Act Primer,” 3. Like investors buying penny stocks in a hot stock market, their focus was on the low price and the strong legal environment for patents. In the current, weak patent law environment, NPEs can purchase high legal quality patent assets, often along with evidence of infringement from innovative operating companies. These are assets that, in stronger patent law environments, NPEs would not have access to because the operating companies would be able to place licenses themselves. It is akin to buying blue chip stocks at depressed prices during a weak period for the stock market.

Viewed through this lens, it becomes clear that NPEs behave like any other investor and respond to changes in the market in economically predictable ways. The NPE business model does not depend on low quality patents any more than a stock market investor relies on companies with poor fundamentals. While there are conditions that make such investments logical, there are others dictating different investments.

With NPEs being prototypical asset buyers, patent owners are the sellers and their behavior is equally predictable. In the strong patent law environment of the late 1990s, financially strapped internet companies sold their patents because they needed the cash more than they needed the patents. In the current weak patent law environment, the decision to sell is predicated on the fact of pervasive efficient infringement and the associated risk and expense required to realize value from the asset. Faced with the risk and expense required to overcome the inertia of efficient infringement, operating companies increasingly make the logical economic decision to divest the assets to parties who can more efficiently realize their value.

Looking to the Future; Applying Lessons of the Past

Put simply, what we have seen through the last generation of strong and then weak patent rights are logical and predictable economic behaviors. While the consequences of a regime of weakened patent rights were not appreciated in advance, going forward policy makers should be cautious about indicting either the innovative operating companies or the NPEs striving to adapt their business models to the market. They should instead look to change the market in ways that fuel innovation in the aggregate.

Our comparison to the stock market is again illustrative. Twenty years ago, the typical stock investor was forced to trade shares of stock through an intermediary—a stockbroker. The development of internet-based trading has disintermediated that industry and given investors the ability to control their own trades. At the same time this investor empowerment evolved, the innovation industry has regressed. Twenty years ago, innovators engaged directly in licensing transactions with licensees, but now they must seek the assistance of intermediaries—NPEs—to derive value from their inventions. The market for innovation has become less efficient at a time when other markets have greatly advanced their efficiency. As stewards of the innovation environment of our country, charged with ensuring it continues to power our economy and provide jobs for our population, this trend should alarm policy makers. It should be our collective objective to expand, not contract the channels to market for innovators.

By making it difficult for innovators to enforce high quality patents, we have caused many of those high quality patents to land in the hands of NPEs. And someday, when the patent law pendulum swings back to strong patent rights, we may find NPEs have become even stronger, having been armed with some of the best patents on the market, patents they originally obtained by taking advantage of the current, weak patent environment.

By accounting for economic reality when formulating patent policy, we can avoid shifting the balance of the patent system towards speculation at innovators’ expense. Twenty years ago, strong patent rights were too easy to abuse, and speculative abusers profited. Now patent rights are too weak and again speculation has become a concern. If our objective is to encourage innovation, then devising a system that rewards innovation should be our top priority, and we should not lose sight of that task by obsessing over the business models of those who realize value from patents.

David J. Kappos is a partner of Cravath, Swaine & Moore. Marc A. Ehrlich is senior vice president of TiVo. Richard M. Ludwin is associate general counsel for the New Solution Group at IBM.