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The chilling effect of patent trolls

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Yu Hou, Gordon Richardson, Feng Chen, Jiaping Qiu

A United States patent grants an exclusive right to make and use an invention for a limited period of time. For one to be granted, an invention must be useful, novel and not obvious. But technology evolves quickly, and what seems obvious today, was less so just a few years ago.

Take NTP and Research in Motion (RIM). In 2001, Virginia-based NTP brought a patent infringement lawsuit against the Canadian company best known for the BlackBerry.

NTP claimed that RIM infringed on its patents for email delivery via wireless systems, but RIM argued the patents were not valid, bringing the case before the US Patent and Trademark Office. Though RIM might have won its claim, with the looming spectre of a court-ordered, system-wide shutdown, and the years-long litigation dragging on growth, in the end it chose to settle. Its co-CEO Jim Balsillie called the US$612.5 million settlement a “pragmatic decision.” Sometimes, it’s just easier to just make this type of lawsuit go away.

“NTP is what’s commonly called a patent troll. These firms acquire patents with the intention of aggressively threatening or pursuing lawsuits,” says Gordon Richardson, a professor of accounting at Rotman.

Patent trolls don’t actually sell anything that uses these patents. Their business model often consists of threatening legal action and sometimes following through. And it can be very effective. It’s estimated that the defendants in patent troll lawsuits lost half a trillion U.S. dollars in wealth between 1990 and 2010.

Patent trolls are most common in the tech sector because both hardware and software can be difficult to define, and it often isn’t clear whether a patent is being infringed. Companies of all sizes can be affected, but smaller companies are particularly vulnerable. That’s because of the associated costs.

“In the U.S., it is expensive to get to court. Even if you win, you pay millions of dollars,” says Feng Chen, an associate professor of accounting at the University of Toronto. “Settlements can be cheaper. Even if you aren’t infringing on a patent, a company might want to settle. Going to court costs money and time.”

But patent trolls don’t only impact those they sue. The authors examined U.S. data on patent infringement lawsuits, stock prices and R&D spending from 2000-2017, and the data revealed that a company’s technological peers were affected too. Companies that make similar technologies were 14 per cent more likely to be sued the year after one of their competitors was.

“When one firm is sued, stock prices decline for peer firms. The risk of a lawsuit goes up because they use similar technologies,” says Yu Hou, a co-author and associate professor at Queen’s University’s Smith School of Business. 

That has ramifications. 

The authors found that when one company was sued, its peer companies lost an average of US$29.8 million in market value. This happens because once one lawsuit is fielded, investors begin pricing in the cost of potential litigation for other companies in that field that might use the same patented technology.

The market is anticipating a common patent troll strategy. These trolls often engage in sequential rounds of lawsuits, targeting multiple firms, one after another.

“A patent troll can look at the top 100 apps in a field in the Google Store, and threaten to sue from smallest to largest,” says Chen.  “Number 100 (the first to be sued) will be small, and going to court costs a lot. They may just be a few people in a garage, and might settle for a few thousand dollars to avoid going to court. This way, patent trolls can continue threatening to sue bigger and bigger companies over the same patent.”

This is wasteful, and when firms do try to protect themselves, they create another type of waste. Peer firms tend to increase R&D spending, but it doesn’t have the desired result. While higher spending on R&D often has a positive effect, in the wake of a patent case, it is often less efficient, leading to a lower number of citations in research and fewer output of new patents. New patents that are filed are typically of a lower value, Hou says.

Regulation and policy could help limit negative impacts

Patent trolls aren’t entirely new. In the early 20th century, lawyer George Selden used his patent on the automobile to collect money from automakers. But today, there are more patents and more companies than ever. And patent trolling can be very profitable – even if it comes at the expense of innovation.

“Given the chilling effect of patent trolls, there needs to be effective ways to limit aggressive litigation strategies. There have been some efforts, including state-level laws that limit patterns of threatening firms or the number of lawsuits that can be filed at one time. These have been more effective than federal attempts. But not as effective as we’d like,” says Richardson. “There are broader negative consequences, and we call for concerted efforts to limit these strategies by regulators at the state and federal levels, especially because of how they make R&D spending less effective.”

But policy makers must also consider a legitimate niche patent trolls sometimes serve – representing the interests of small inventors.

“Big tech firms like Apple and Google monopolize certain technology fields, and small inventors lack the resources to fight them, when their patents are infringed upon,” says Hou. “Small inventors could be students or professors and might not get a fair price when their technology is used. Patent trolls potentially align with their interests. They buy patents and use their resources to sue large firms. They are a little like lawyers. Everybody hates lawyers, but they do a job — and that is justice. It's just that with patent trolls, their job seems to be abused a little bit.”

The research work, coauthored by Chen, Hou, Richardson, and Jiaping Qiu (a professor of finance at McMaster University), was recently published in Research Policy.

Feng Chen is an associate professor of accounting in the department of management at the University of Toronto Mississauga, with a cross-appointment to the accounting area at Rotman. 
Yu Hou is an associate professor at Smith School of Business.
Jiaping Qiu is a professor of finance and business economics at the DeGroote School of Business.
Gordon Richardson is a professor of accounting at the University of Toronto.