The US Department of Justice Antitrust Division (DOJ) has been grappling with how to analyze the competitive effects of patent portfolio transactions for some time. It reviewed and ultimately cleared several significant portfolio transfers in early 2012, including Google’s acquisition of Motorola Mobility and the acquisition of Nortel’s patent portfolio by a consortium of technology companies including Apple, Microsoft, and Research In Motion. DOJ issued a closing statement explaining its rationale for clearing those transactions, but it was focused entirely on the standard essential patents in the acquired portfolios. In a recent speech, chief DOJ economist Fiona Scott-Morton announced an analytical framework that provides more guidance on how DOJ intends to evaluate such transactions in the future. According to Scott-Morton, the strategy and business model of the acquiring entity will have a significant impact on the DOJ’s analysis of the proposed acquisition.
Scott-Morton laid out four different transaction scenarios, each involving an acquirer with a different business model. First, she discussed patent acquisitions by “non-practicing entities” (NPEs), which are organizations that own patents but do not produce any products for consumers. Scott-Morton distinguished between two types of NPEs: “textbook” NPEs, such as academic research institutions, and Patent Assertion Entities (PAEs), which Scott-Morton called “trolls.” The latter, according to Scott-Morton, are entities that acquire large quantities of patents from others with the intent to monetize those patents as the entity’s primary business model. Scott-Morton stated that these entities have unique incentives where “the transaction cost of determining infringement and validity are high, practicing entities are already using the technology and will incur costs to design around it, and a troll can threaten injunction or exclusion orders” without fear of retaliation because “trolls” do not sell any products themselves. In such a world, according to Scott-Morton, “we will see trolls obtaining royalties in excess of the market value of the IP.” She also noted that PAEs can take advantage of the incomplete nature of the contracts already written on the IP, such as commitments to license the technology on reasonable and non-discriminatory (RAND) terms that may not travel with the IP. Therefore, she concluded, acquisitions of significant patent portfolios by such entities are likely to increase the marginal costs of all industry participants and “may reduce consumer choice to the extent that expected high royalties discourage entry and innovation.” This could indicate that while DOJ has not conducted any in-depth investigations of patent acquisitions by “trolls,” it may intend to scrutinize such acquisitions in the future.
Second, Scott-Morton analyzed patent acquisitions by practicing entities that compete in the downstream product market of interest (e.g., wireless devices). Scott-Morton posited that such entities may have an incentive to charge more to their competitors, “which distorts competition in the market” by raising rivals’ costs to divert more sales to the IP acquirer. According to Scott-Morton, the DOJ’s traditional vertical merger analysis can effectively assess the likelihood of harm from such transactions.
The third scenario involved a joint venture (JV) between a practicing entity and a PAE in which the JV would monetize the IP by using the PAE’s reputation and negotiating skills to extract license revenue from practicing entities. Scott-Morton stated that this scenario “combines the reasons for higher royalty rates” from the first and second models because the practicing entity has an incentive to raise rivals’ costs and the PAE has an incentive to extract maximum royalties without fear of retaliation.
The final scenario is a JV between a PAE and a group of practicing entities. According to Scott-Morton, this model raises the same concerns as the third scenario, but it also incorporates an additional potential problem – it may facilitate coordination or collusion between competitors to disadvantage a rival or deter entry. Scott-Morton stated that the practicing entity members of the JV “are firms that are in theory competing with each other in the product market, and instead are cooperating, through the troll, to raise rivals’ costs and share the profits from doing so.”
Scott-Morton’s speech is a succinct summary of DOJ’s current approach to analyzing patent acquisitions, and it represents the most detailed delineation of the different types of patent acquisitions that may receive scrutiny from DOJ. Parties whose proposed transactions fit into one of these scenarios must be prepared to address the theoretical concerns articulated by Scott-Morton, and they should work with antitrust counsel before signing to ensure the transaction is structured in a way that will minimize the risk of a DOJ investigation that could ultimately block the acquisition (or unwind the deal post-closing if the transaction did not meet the pre-merger notification thresholds).