On March 7, 2011, the Federal Trade Commission (FTC) issued a 300-page report, "The Evolving IP Marketplace: Aligning Patent Notice and Remedies with Competition," that examines the interplay between patent issuance, patent remedies, innovation and competition. The report was issued following eight days of hearings that began in 2008 as well as a workshop co-sponsored by the FTC, the U.S. Patent and Trademark Office (USPTO) and the Department of Justice, Antitrust Division (DOJ). The report is the FTC’s latest effort to influence policy regarding the way in which patents and litigation of patent rights affects innovation, new entry and consumers.1

The FTC makes recommendations in two principal areas: (1) notice of the scope of the protected technology and (2) patent damages and injunctive remedies.

Adequate Notice of the Scope of Patent Protection

With respect to notice the report considered and provided recommendations on the following three principal issues relating to notice: (1) the need for clarity in patent claim drafting to better delineate the scope of the invention to allow a person skilled in the relevant art to understand the scope of the claims and therefore, to understand what method(s), system(s), or apparatus(es) would and would not infringe a given patent; (2) the need to avoid or minimize the current circumstance in which, due to the lag time between when a patent is filed and when the patent application is available to the public, infringing knowledge of products or methods may be developed in good faith without knowledge of a patent because, at the time of development, the patent application was not accessible to the public; and (3) the need to reduce the difficulty in identifying and reviewing relevant prior art patents due to the significant volume of patents resulting from prior art searches, particularly in the area of information technologies.

The Definiteness Requirement During Prosecution

The requirement for clearly delineated patent claims is already a requirement of patentability under the definiteness requirement of 35 U.S.C. 112, 2d paragraph, which requires that "[t]he specification shall conclude with one or more claims particularly pointing out and distinctly claiming the subject matter which the applicant regards as his invention." The report encourages the USPTO to apply the higher standard to this "definiteness" requirement during the prosecution process because it is during this time that the inventor has the ability, and indeed the obligation, to further clarify the scope of the claims. Ex Parte Miyazaki, 2008 Pat. App. LEXIS 26 at *9-16, 89 U.S.P.Q.2d 1207, 2008 WL 5105055 at *5-6 (Bd. Pat. App. & Interf. Nov. 19, 2008). Under this standard, the examiner must determine whether a claim is sufficiently definite such that "those skilled in the art would understand what is claimed when the claim is read in light of the specification." Id. Thus, during prosecution, if a claim is amenable to two or more plausible claim constructions, the USPTO is justified in requiring the applicant to more precisely define the metes and bounds of the claimed invention by holding the claim unpatentable under 35 U.S.C. § 112, second paragraph, as indefinite.

The report also recommends a number of additional practice changes to increase notice to persons of skill in the relevant art. The report recommends that the courts’ recent focus on means-plus-function claims and the requirement of disclosure of a structure performing the function be continued and extended to address functional claiming in general. The report seeks more predictability in claim terms through recommendations that applicants be required to include definitions or identify a dictionary for reference during claim interpretation. Finally, the report encourages examiners to build a more robust record during the prosecution process through more substantial and more informative use of statements of reasons for allowance, reasoning that more clear explanations of allowance will further assist persons of relevant skill in the art to understand the scope of the patent.

Increasing Public Access to Patent Applications

To decrease the lag between when a patent application is filed and made publicly available, the report recommends legislation requiring publication of patent applications 18 months after filing, whether or not the applicant has also sought patent protection abroad.

Increasing the Effectiveness of Prior Art Patent Searching at the USPTO

To improve the effectiveness and efficiency of prior art searching, the report recommends that USPTO examiners classify patents using an industry-based classification system in art units in which the additional classifications would significantly improve public notice. Although the report provides little additional guidance, it does specifically call out the information technology and software industries as sectors in which it believes such reclassification would be helpful. The report also recommends that legislation be enacted that requires the public recordation of assignments.

Patent Relief Awarded Against the Infringer

The goal of injunctive relief and damages should be to replicate the "market reward" that the patent holder would have achieved absent infringement. While acknowledging that patent remedies are an important part of the patent system’s incentives to innovate and are aligned with competition policy, the report concludes that some of the legal rules and practices used by courts and litigants are not based on sound economic principles, and, consequently, either undercompensate or overcompensate patentees for the infringement. Undercompensation is problematic for the obvious reason that it undermines the incentives to innovate. Overcompensation can result in higher prices. It can also encourage speculation in patent rights and litigation, which can deter innovation by raising costs and increasing the risks of investment in IP.

Reasonable Royalty Damages

When a patentee does not sell its own invention, it can earn its market reward through licensing payments. Accordingly, when a patentee cannot or chooses not to prove lost profits, the measure of damages is at least the amount that the patentee would have received from licensing the patented technology – a reasonable royalty. The reasonable royalty damages are determined using a hypothetical negotiation based on what a willing patentee and willing licensor would have agreed to in a licensing negotiation at the time of first infringement.

The report, however, expresses concern over the idea that some courts allow a greater damage award than would have been negotiated. The FTC identified three primary reasons that courts might overcompensate the patentee: (1) they were being punitive; (2) the royalty that would have been acceptable to the patentee was greater than the maximum the infringer would have paid; or (3) the reasonable royalty would have been an insufficient deterrent to infringement.

In order to avoid overcompensating patentees and the resulting market distortion, the report recommends that reasonable royalty damages be limited to only the hypothetical patent license negotiation. Deterrence, punishment and other concerns should not be permitted to inflate the reasonable royalty. In addition, to avoid overcompensating patentees in industries subject to standardized technologies, the FTC recommends that courts cap the royalty at the incremental value of the patented technology over the alternatives available at the time the standard was established.

Lost Profits Damages

When a patentee commercializes its own invention, the measure of damages for infringement is lost profits. According to the report, "[t]o accurately replicate the market reward that the patentee would have earned by practicing its invention, the lost profits damages calculation must account for competition that the patentee’s product would have faced if the infringer had sold a non-infringing alternative that did not incorporate the patented technology." To avoid overcompensation in cases in which the infringed invention is only one component of a more complicated product, the report recommends that courts reject damage models that simply seek the value of the entire product, including components in addition to the infringed technology. The FTC instead suggests a more nuanced economic analysis of assessing the extent to which consumers view a patented component as a valuable feature of the larger product or as a minor feature that they would forgo at higher prices or substitute with a non-infringing alternative.

The report repudiates any lost profits approach that ignores competition from non-infringing alternatives because the infringer might very well have sold a non-infringing technology in a world absent infringement. The FTC recommends that the courts engage in a more careful economic analysis and examine consumer preference for the patented technology and the level of substitutability between the patented technology and any non-infringing alternatives. The recommended analysis is similar to that used to construct a market and measure the putative effects of a proposed merger.

Also, the FTC criticizes what it terms "dual awards" of lost profits and reasonable royalties because it believes that such awards overcompensate the patentee.2 The report explains that this problem occurs when a patentee is awarded lost profits on the sales lost as a result of infringement in addition to a reasonable royalty on sales of infringing product that did not result in lost profits (for example, because the sales took place when the patent owner was not competing in the market). The FTC argues that such dual awards ignore the competition that the patented invention faces from non-infringing alternatives and thus distorts the IP’s value. Accordingly, the FTC recommends that courts "reject dual awards of lost profits and reasonable royalty damages when competition from alternatives would have prevented the patentee from making all the infringer’s sales in a world but for infringement."

Injunctive Relief

Courts often impose permanent injunctions in addition to awarding monetary damages against the infringer. The report acknowledges that injunctive relief is consistent with the goal of the patent system and the antitrust laws of fostering innovation through preservation of exclusivity, deterrence and promotion of licensing. The FTC generally agrees with the Supreme Court’s ruling that the same factors must be proven in patent cases as are in other types of cases and that there is no special presumption that patentees are entitled to an injunction. The report, however, attempts to provide guidance on how to apply the injunction factors.

The FTC expresses particular concern when the threat of an injunction can lead an infringer to pay higher royalties than patentees could have obtained in a competitive market. Such excessive royalties would occur when a patentee can use the threat of an injunction to get royalties covering not only the market value of the patented technology but also a portion of the costs that the infringer would incur if it were enjoined and had to switch to a non-infringing alternative. This royalty based on switching costs is called the "hold-up" value of the patent. The report recommends that courts consider the potential for hold-up royalties when balancing the hardships between the parties and when considering the public interest.