On October 6, 2016, the Federal Trade Commission released its long-awaited study on Patent Assertion Entities (“PAEs”). A PAE is an entity that acquires patents and generates revenue by asserting those patents against alleged infringers (e.g., potential licensees). PAEs do not develop or sell products implementing their patents. There has been a persistent debate in the antitrust and patent law communities regarding whether PAE conduct is beneficial or harmful from competition and innovation perspectives. The FTC relied upon its authority under Section 6(b) of the Federal Trade Commission Act to study PAEs and their business models over a five-year period.

Overview

  • The FTC finds that PAE litigation can have the negative effect of hampering innovation by diverting R&D resources, unfairly disadvantaging small firms and start-ups, and imposing license and litigation costs that exceed the value of the patented technology at issue.
  • The FTC has recommended that the legislature and judiciary—as opposed to application or revision of the antitrust laws—address the inherent advantages that PAEs have in filing patent infringement cases through case management, amended rules of civil procedure, and streamlining similar actions.
  • The FTC did not comment on PAE behavior more generally (e.g., buying and asserting patents with no intention of using those patents), but instead focused on the potentially harmful effects of PAEs filing frequent and often “nuisance” lawsuits.

PAE Business Models

The FTC identified two types of PAEs in its study: (1) Portfolio and (2) Litigation.1 Portfolio PAEs negotiate licenses over large portfolios, often containing hundreds of patents valued at millions of dollars. They typically raised funds through institutional investors and manufacturing firms to acquire patents. Portfolio PAEs generated 80% of all reported PAE revenue in the FTC’s study, or approximately $3.2 billion, despite accounting for only 9% of the reported number of PAE licenses.2 Portfolio PAEs frequently negotiate licenses through demand letters or other means without filing a patent infringement lawsuit against accused infringers.3

Litigation PAEs, on the other hand, typically file suit against alleged infringers and then hastily settle by entering into licenses under the asserted patents. According to the FTC’s study, 93% of licenses obtained by Litigation PAEs followed a patent infringement action.4 Portfolios of Litigation PAEs tend to cover ten or fewer patents, which are often acquired through revenue sharing agreements with the patent sellers.5 Litigation PAEs accounted for 91% of reported licenses in the FTC’s study, but these licenses only resulted in approximately $300,000 each in royalties.6 Given that $300,000 is the estimated cost of early-stage patent litigation and discovery, the FTC characterized these PAEs as being engaged in “nuisance litigation.”7

There has been much debate regarding harms potentially caused by PAEs. The FTC and prior commentators identified three categories of harms, all of which have the potential to reduce innovation—an effect fundamentally at odds with the objectives of the patent system. First, PAE lawsuits can result in high litigation costs and licensing fees that do not correspond with the value of the patented technology.8 Second, these infringement suits can greatly disadvantage small companies and start-ups (which are less able to afford the litigation costs), ultimately hampering investment and technological development.9 Finally, the uptake in litigation and the need for these targets to defend themselves against infringement could divert corporate resources away from research and development, and other valuable competitive endeavors.10 The FTC has thus proposed several legislative and judicial recommendations to combat this type of PAE litigation.

Addressing Discovery Asymmetries

The first proposal is to “[d]evelop rules and case management practices to address [the] discovery burden and cost asymmetries in PAE litigation.”11 During the early stages of litigation, parties exchange relevant information through the discovery process. Given that PAEs do not develop, manufacture, or sell goods or services, they generally have less information subject to discovery, and can file suit without the fear or risk of early discovery costs. Litigation PAEs thus have an advantage in filing these lawsuits. The FTC observed that Litigation PAEs settled 66% of their cases within one year, and 83% within 18 months.12 These settlements were typically valued at less than $300,000, while the average cost of patent litigation is estimated to be between $300,000 and $2.5 million.13 The study indicates that the burden of discovery, rather than the value of the relevant patents, likely drives the accused infringers to settle. The FTC has thus recommended that Congress, the Judicial Conference, and the courts try to reduce this asymmetry in discovery and litigation costs, with proposals such as encouraging early disclosure of asserted claims and validity contentions, limiting the amount of discovery before the motions stage, and requiring early disclosure of damages.14

Clarifying PAE Relationships

The second proposal is to “[a]mend Federal Rule of Civil Procedure 7.1 to reach a broader range of non-party interested entities or persons.”15 Litigation PAEs typically create a new affiliate company for each small portfolio that they acquire. The parent entity of these affiliates, as well as the relationship among PAEs, is often unclear. This corporate structure increases the difficulty of alleged infringers in determining whether they may already have a license through a related entity or to identify the parent with actual control over the relevant affiliate. Rule 7.1 frequently does not cover multi-affiliate Litigation PAEs, which subsequently do not need to disclose their financial relationships to the judge. Amending the Rule would therefore help potential licensees and the courts to develop a better understanding of the corporate and financial relationships between PAEs and their affiliates.

Promoting Judicial Stays

The FTC’s next proposal is to “[e]stablish procedures encouraging courts to stay a PAE’s infringement action against a customer or end-user, where the PAE has also sued the manufacturer of the accused product under the same theory of infringement.”16 Given that patents permit owners to file suit against anybody that uses the patents, Litigation PAEs often file suit against manufacturers and customers for the same infringement. Product manufacturers, however, tend to be in a better position to defend themselves in patent litigation, and their suits could ultimately render the customers’ suits moot (e.g., if the patent is found invalid). The FTC therefore proposes new laws encouraging courts to stay patent infringement actions against customers, pending the resolution of similar actions against manufacturers.

Heightening Pleading Standards

The FTC’s final proposal is to continue to amend pleading requirements to “ensure that patent infringement complaints provide sufficient notice to accused infringers.”17 In December 2015, for example, the Federal Rules of Civil Procedure were amended to increase the pleadings or plausibility threshold for complaints in patent infringement actions.18 The FTC recommends that courts continue to assess plausibility standards and require more particularity in patent infringement complaints, which would force Litigation PAEs to provide additional facts and allegations to assess the nature of their claims.