On May 22, 2013, Vermont became the first state in the US to pass legislation specifically directed towards curbing the abuse of frivolous patent enforcement actions. The new law, "Bad Faith Assertions of Patent Infringement" (H.299 §§ 4195-4199), gives individuals, businesses and nonprofits targeted by patent infringement threats the means to sue a patent enforcer who engages in dubious patent enforcement actions or licensing activities. If the law survives preemption challenges, it may be a powerful new weapon for companies that can claim to have "Vermont person" status to challenge meritless patent infringement claims.1

The Vermont Statute Takes Aim at Bad Faith Patent Claims

The new law outlines several factors which may be deemed "bad faith assertions of patent infringement." These include the following:

  • Failing to provide proper notice of the owners and assignees of the patent in demand letters
  • Demanding unreasonable royalties
  • Asking for licensing fees within an unreasonably short period of time from demand
  • Failing to conduct a proper analysis of the claims against the target's products, services and technology before sending a demand letter
  • Failing to identify "specific areas in which the products, services and technology are covered by the claims in the patent"
  • "Deceptive" and "meritless" infringement assertions

All in all, the statute outlines higher standards for would-be patent plaintiffs than are imposed under Federal Rule of Civil Procedure 11 which has been used by defendants as a means of seeking sanctions against plaintiffs who have brought frivolous patent infringement claims without proper due diligence. The Vermont statute is unique in that it provides a cause of action not only for targets based on "demand" or "cease and desist" letters, but also for companies that have already been sued for patent infringement. If the target establishes that there is a reasonable likelihood that a person has made a bad faith assertion of patent infringement, it can force the patent enforcer to post a bond in an amount equal to the target's estimated cost of defense (not to exceed $250,000). If successful in proving a violation under the statute, the target may obtain equitable relief, damages, costs and attorneys fees and exemplary damages in an amount equal to $50,000 or three times the total damages, costs and fees, whichever is greater.

Also the statute provides the attorney general of Vermont authority to bring civil investigations and civil actions to enforce the law. Perhaps not coincidently, this law comes on the heels of a Vermont AG lawsuit against a non-practicing entity (NPE) under the "Vermont Consumer Protection Act," targeting an NPE's patent licensing campaign against small businesses.2 Among other things, the lawsuit alleges that defendant's patent licensing campaign unlawfully demanded payments from thousands of companies in Vermont by sending letters that threatened patent infringement litigation with no evidence that the recipients were infringing its patents; shifting the entire burden of pre-suit investigation onto the small businesses that received the letters; propounding burdensome information demands on businesses that claimed not to infringe the patents; and using shell corporations in order to hide the true owners of the patents, avoid liability and encourage quick settlements.

The Vermont statute and AG lawsuit reflect a growing awareness by governments that patent litigation targeting small businesses for settlements and sums that range from "nuisance value" (from four to six figures) to the "cost of litigation" (seven figures) are amounting to an unfair tax on businesses that hurt innovation and drive up the cost of business to unsustainable levels. While the recently enacted America Invents Act (AIA) has reformed several areas of patent law, many industries have argued that it has not gone far enough to protect businesses from illegitimate claims of patent infringement. At the national level, a bill has been recently introduced in Congress called the SHIELD (Saving High-tech Innovators from Egregious Legal Disputes) Act, designed to protect American companies from frivolous patent lawsuits. The SHIELD Act, if passed, would include fee-shifting provisions that put the financial burden on non-practicing entities that buy patents solely to sue companies.

The Vermont Statute May Face Potential Preemption Challenges

While many industries will applaud Vermont for taking a bold step in the direction of meaningful patent litigation reform, the new law is not without potential problems. Given the effect and intent of the law to regulate aspects of patent enforcement and litigation, a province of federal jurisdiction, it is conceivable that the statute will be challenged under the preemption doctrine.

As the US Supreme Court stated in Altria Group v. Good, 55 US 70 (2008), a federal law that conflicts with a state law will trump or “preempt” that state law. 28 U.S.C. §1338 (a) provides exclusive jurisdiction with respect to claims arising under the patent laws to the district courts. There are several provisions in the Vermont statute that may be subject to preemption challenges. For example, the Vermont statute includes in its definition of a target a Vermont person “against whom a lawsuit has been filed alleging patent infringement." One might argue that by targeting actual patent litigation, the statute is attempting to regulate patent enforcement actions in federal court. The Vermont statute further lists a variety of factors for determining bad faith assertions, including a determination of whether prior to sending a demand letter an analysis was performed identifying “specific areas in which the target’s products, services, and technology infringe the patent or are covered by the claims of the patent,” as well as whether any factual allegations in a demand letter include such “specific areas.” The determination of whether the “specific areas” requirement of the Vermont statute has been satisfied may require a showing of whether the patent claims have been sufficiently mapped to the accused products or services, an analysis that may implicate 35 U.S.C. § 271 et seq.

Additionally, the Vermont statute appears to create liability when the assertion of patent infringement is “meritless, and the person knew, or should have known, that the claim or assertion is meritless.” It is unclear whether this provision would require the state court to wait for the federal courts to decide the merits of the underlying patent case or would allow the state court to engage in its own analysis of the patent infringement merits, such as by engaging in claim construction and interpretation of the patents, a procedure that is normally conducted as a Markman hearing in federal court. Also, the Vermont statute’s provision of an attorneys' fee award, one might argue, conflicts with 35 U.S.C. § 285, which requires the federal court to determine whether the underlying patent case is “exceptional” prior to awarding reasonable attorney fees to the prevailing party. Similarly, it is possible that the Vermont statute’s bad faith factor relating to the offered license amount not being based on a “reasonable estimate of the value of the license” conflicts with 35 U.S.C. § 284, which directs the district courts to assess damages and, when necessary, determine what constitutes a reasonable royalty.

Indeed, the Vermont General Assembly itself was worried about preemption when it included the following language in the statute: "The General Assembly does not wish to interfere with the good faith enforcement of patents or good faith patent litigation. The General Assembly also recognizes that Vermont is preempted from passing any law that conflicts with federal patent law." Section 4195 (a)(3).

In spite of the above preemption concerns, recent US Supreme Court precedent, such as Gunn v. Minton, 133 S. Ct. 1059 (2013), may give proponents of the statute valid arguments that states may lawfully regulate certain aspects of patent litigation as long as they are consistent with federal law. In Gunn, the Supreme Court held that 28 U.S.C. § 1338 (a) does not deprive the state courts of subject matter jurisdiction in a patent malpractice case. The Supreme Court stated that although patent malpractice claims raise a federal issue, such a federal issue is not “substantial” because, irrespective of how the state court resolves a hypothetical patent “case within a case,” the result of the federal patent litigation will not change.

What Does it All Mean to Patent Enforcement?

Should the Vermont law hold up to likely preemption challenges, businesses that have some connection to the state of Vermont, either through incorporation or sufficient contacts with the state (that would permit jurisdiction and standing to enforce the new law), may have effective new defenses against NPEs engaging in "bad faith" serial patent litigation or licensing campaigns. Companies may consider strategically using the Vermont statute to create significant disincentives and downside risks for NPE enforcement of patents by directly suing NPEs for bad faith patent enforcement activities or request that the AG initiate a civil investigation or action against the NPE. Such a lawsuit or investigation may be used as a preemptive or defense measure against existing or threatened patent litigation. Moreover, given the national, state and local government interest in this issue, along with intensive lobbying efforts by the high tech industry to curb the abuse of frivolous patent litigation, other states may soon follow with similar laws on their books.