At a time when congressional partisanship is the norm, curbing lawsuits filed by nonpracticing entities (NPEs) may be one of the few issues uniting Washington. Over the past year, both Republicans and Democrats introduced several bills in the House and Senate targeting NPEs. Proposals have been made to heighten pleading standards,1 shift attorney’s fees to the non-prevailing party,2 limit pre-claim-construction discovery,3 increase the transparency of patent ownership,4 legislate stays for downstream customers and retailers,5 address so-called bad faith demand letters,6 and expand post-grant review opportunities.7 In sharp contrast to the popular view that Congress is rife with deadlock and capable of passing only last-minute, emergency legislation, these patent proposals are gaining bipartisan support even though they are sweeping, ambitious, and arguably do too much too soon without necessarily solving the problems the proposals hope to address.
Many of the reforms suggested by Congress are procedural, focusing on the day-to-day operations of federal district courts. Several preeminent jurists have expressed concerns regarding what they consider to be congressional interference, arguing that these proposals overstep the traditional boundaries between the Article I powers of the Legislature and the Article III prerogatives of the Judiciary. For example, in a recent speech at the Eastern District of Texas Bench and Bar Conference, Federal Circuit Chief Judge Randall Rader lamented the attempts of Congress to define and categorize the “troll” problem, advocating instead for judicial correction to what he views as a broader litigation abuse problem.8 Similarly, Federal Circuit Judge Kathleen O’Malley has publicly argued that Congress’s attempt to dictate patent litigation rules is an invasion of the independent Judiciary guaranteed by the Constitution.9
Even if the current legislative proposals do not run afoul of the Constitution’s separation of powers, the breadth of the proposals carries a high risk of unintended consequences—particularly for smaller entities, universities, and research organizations. This is in large part due to the definitional problem surrounding NPEs.10 In many cases, the line between a patent “troll” and a small research entity is blurry at best. As a result, legislative action aimed at curbing extortive NPE behavior may inadvertently erect barriers for small entities and universities to legitimately assert their patent rights.11
Moreover, a recent study even suggests that Congress is not only attempting to enact overly broad legislation, but it is doing so to solve a problem that does not exist. The study, which examined all patent cases between 2010 and 2012, found that, although the number of patent suits nearly doubled during that period, the number of patentees filing suit remained relatively constant.12 The study concludes that the recent spike in patent suits is not caused by the sudden appearance of a horde of NPEs but by changes to joinder rules under the America Invents Act.13 Former United States Patent and Trademark Office (USPTO) Director David Kappos has commented that this study supports the notion that stories of rampant “troll” lawsuits are largely anecdotal.14
Regardless of whether one considers “troll” litigation to be approaching critical mass or merely an aftereffect of recent patent law reform, a growing likelihood exists that further changes in our patent laws will happen, perhaps as soon as the current session of Congress. Thus, an examination of one of the more significant pending legislative proposals, customer stays, is timely.
II. A REAL PROBLEM: CUSTOMER SUITS
Acquisition and enforcement of patents—the basic practice of NPEs—is not problematic in and of itself. Patents are freely transferrable, and their enforcement ensures that their value is preserved. However, problems do arise when NPEs are able to exploit the high costs of patent litigation to extract money from a patent whose worth might only be measured by the cost burden that patent litigation entails. This practice is most apparent in the context of customer suits.
Customer suits are suits filed by NPEs against consumers, end users, and retailers for sale or use of allegedly infringing products. A recent classic example was a patent suit against the Whataburger restaurant because it installed third-party supplied wireless capability in some of its restaurants thereby allegedly infringing a wireless patent.15 In such cases, the NPE will often make an offer to settle and license the technology for well below the cost of litigation. The chance to settle a potential lawsuit for this “nuisance” value is one many customers understandably accept.16 By setting the price of settlement and licensing so low that challenging the validity of the patent is uneconomical, the NPE can continue extracting settlements from other customers, at least until the patent expires, a customer takes the risk involved in challenging the patent (and prevails), or the NPE runs out of customers to sue. In the Whataburger case, Whataburger simply removed the third-party wireless capability rather than incur the expense of a patent lawsuit.17
The customer suit problem is a problem of incentives. Because the potential costs of fighting infringement outweigh the potential benefits to the customer, the customer’s only rational choices are to pay the settlement amount, stop buying or using the allegedly infringing product, or hope the supplier will step into the suit and provide full indemnification. Contributing to the customer’s costs is a general unfamiliarity with relevant prior art and the structure and operation of the accused product. This technical knowledge is important for an efficient and effective challenge to the asserted patents.
In addition to the high costs required to challenge infringement, the potential upside to a customer for a successful challenge is limited. Unlike a manufacturer or supplier, a customer has a limited stake in the long-term implications of the asserted patent’s continued validity. The customer need only pay a one-time fee to be free of harassment by the NPE. Indeed, once a customer has paid for a license, it may prefer to keep the patent alive in the hopes that the NPE will turn around and foist similar claims and costs on the customer’s competition in order to even the playing field.
Compare each of the foregoing realities to those of a manufacturer. First, the manufacturer typically has the best knowledge of the technical area of the invention and any prior art, reducing the costs of research and “getting up to speed.” Second, as long as the patent remains valid, the manufacturer’s current and future business prospects are at risk. As a result, the long-term costs for the manufacturer very well could exceed the costs of the licensing fee faced by the customer as well as the cost of litigation. Finally, although the manufacturer may benefit from a competitor being sued under the patent, the potential loss of customers may outweigh any such benefits. Taken together, these factors position the manufacturer as a better-equipped and better-incentivized defendant in litigation.
How widespread is the customer suit problem? Although individual examples of suits filed by NPEs against customers and end users abound,18 the available data is inconclusive as to whether there is a genuine customer suit epidemic or if the increase is a result of changes under the America Invents Act.19 That said, several statistics shed some light on the scope of the issue. Of all the suits filed in 2012, over 60% were filed by NPEs.20 In those cases, 55% of unique defendants had annual revenues of $10 million or less.21 With the average cost to defend a relatively low-stakes NPE lawsuit to judgment around $600,000,22 the decision to defend an infringement claim could come at a grievous relative cost to many small companies.
In addition to persistent targeting of small entities, the past five years have also seen a marked increase in the number of low-tech or non-tech defendants in NPE-related suits. For example, the GAO estimates that 84% of all NPE lawsuits filed between 2007 and 2011 involved software patents.23 Among those cases, over 39% were filed against nontechnology entities like retailers and local governments.24 These factors—litigation costs as a high percent of annual revenues and minimal technical knowledge—combine to make many defendants in NPE-related litigation easy targets for abusive litigation tactics.
Although the exact scope of the customer suit problem may be difficult to ascertain, the problem exists and results in a waste of customer and judicial resources. Further, the practice of leveraging high litigation costs to extract excessive value from patents conflicts with the patent system’s primary objective of rewarding innovation. As a result, unlike the broad reforms proposed in recent legislation—many of which may have unforeseen and negative impacts—an approach targeted directly at the customer suit problem through an aggressive stay mechanism has promise in addressing the objective of legislators and rule-makers to reduce NPE abuse. Of course, any stay mechanism, whether by statute or court rule, may have unforeseen complexities given that creative patent application drafters could well draft future patent applications that more directly implicate customers and make application of a present-day stay mechanism less successful in the future. In light of such issues, policymakers should take note of the current system of customer stays and the potential problems with currently proposed legislation.
III. CUSTOMER STAYS
A. The Existing Customer Suit Exception
One of the most direct ways of minimizing exploitation of the high cost of litigation by NPEs is to permit staying a customer suit while a suit against the manufacturer of the allegedly infringing product is pending. Doing so allows the customer to benefit from a finding of invalidity or noninfringement in the manufacturer suit without expending the resources required to see their own suit through to judgment. Of course, this may not work if the patent holder simply avoids ever suing the manufacturer. Thus, liberal allowance of intervention by a manufacturer would be a necessary corollary to a customer stay.
The idea of a customer stay is not new. Currently, under the so-called customer suit exception, a federal district court has the ability to stay an infringement suit filed against a customer pending the results of a later-filed declaratory judgment by a manufacturer.25 Unfortunately, case law surrounding the exception is rife with restrictions that limit the application of the exception.
The customer suit exception is rooted in the general power of courts to determine the order and priority of the cases before them.26 Because the exception originated in civil procedure and not patent law, the sole criterion used by courts for exercising the customer suit exception is judicial economy.27 Considerations unique to the patent system, including the relative abilities of the customer and manufacturer to challenge validity of the patent, larger policy concerns regarding a robust patent system, and long-term effects on patent litigation, are not considered.28 So, unless the result of the suit involving the manufacturer would dispose of all issues in the current and any future customer suits, the exception will not be applied.29
In light of these limitations, the customer suit exception is largely ineffective as a tool to increase manufacturer intervention in customer suits.30 However, recently proposed legislation provides a basic framework for a more effective solution.
B. Customer Stays Under Currently Proposed Legislation
Among the various legislative proposals, the Innovation Act and its Senate equivalent, the Patent Transparency and Improvements Act (PTIA), provide the most comprehensive attempt at curbing NPE litigation and include a customer stay provision.
In general, the Innovation Act allows a stay of customer suits if the following conditions are met:
- The customer and manufacturer consent to the stay;
- The manufacturer is “a party to the action or to a separate action involving the same patent or patents related to the same covered product or process;” and
- The covered customer “agrees to be bound by any issues that the covered customer has in common with the covered manufacturer and are finally decided as to the covered manufacturer . . . .”31
The PTIA largely tracks the Innovation Act but differs regarding the agreement to be bound.32 First, the PTIA’s agreement to be bound is premised on the principles of collateral estoppel and applies to any issue finally decided that is common between the covered customer and the covered manufacturer.33Second, under the PTIA, if the manufacturer seeks or enters into a consent judgment or fails to prosecute issues to a final nonappealable judgment, the court may eliminate the agreement to be bound on a showing that not doing so would be manifestly unjust and unreasonably prejudice the customer.34
Under either resolution, if a customer and manufacturer meet the necessary requirements, “the court shall grant a motion to stay at least the portion of the action against a covered customer related to infringement of a patent involving a covered product or process.”35
C. Problems with and Improvements to Proposed Legislation
As currently written, the customer stay provisions of both the Innovation Act and PTIA have several problematic gaps. As a result, they have been slow to gain widespread approval. Notably, three major national intellectual property organizations, the American Intellectual Property Law Association (AIPLA), the Intellectual Property Owner’s Association (IPO), and the Intellectual Property Section of the American Bar Association (ABA), have either disapproved of the existing proposed legislation or given only qualified support.36
1. The “Same Patent” Requirement. Both the Innovation Act and PTIA require the manufacturer to be a party in an action involving “the same patent or patents related to the same covered product or process.”37 A covered product or process is defined as “a product, process, system, service, component, material, or apparatus, or relevant part thereof, that (A) is alleged to infringe the patent or patents in dispute; or (B) implements a process alleged to infringe the patent or patents in dispute.”38
By requiring manufacturers be sued under the same patent or patents, the proposed customer stay provisions are too narrow. Specifically, requiring the manufacturer and customer be sued under the same patent ignores the common practice of obtaining continuation patents. Continuation patents, while distinct from their parent patents, often include claims that are quite similar to the claims in their parents.39 As a result, an NPE could simply assert the parent patent against a customer and the continuation patent against the manufacturer to avoid a customer stay.
To prevent this type of gamesmanship, consideration should be given to modifying the customer stay provision to account for patent families. A relatively straightforward way of addressing patent families would be to trace the lineage of the patents asserted against the customer and the manufacturer and determine whether they share a common parent application. If so, then the subject matter of the two patents is likely to be closely related enough to warrant intervention by the manufacturer. Thus, the current stay provision might be modified to apply to manufacturers who are “a party in an action involving the same patent or patents, or a patent or patents sharing a parent application.”
2. Binding Effects of Manufacturer Suits. The Innovation Act and PTIA also require the customer to agree to be bound by any issue it has in common with the manufacturer.40 However, neither proposal clearly defines the legal issues that would trigger a binding effect. To address this ambiguity, the stay provision ought to identify the specific legal issues on which the customer may become bound by the outcome of the manufacturer suit.
The nature of legal issues on which the customer may become bound should reflect the underlying purposes of the customer stay provision. As discussed earlier, customer stays are advantageous because the manufacturer typically has superior knowledge and experience with the patented technology and prior art. This advantage is tied directly to the issues of validity and infringement, and, therefore, the binding effect of any stay should primarily focus on only those two issues. In other words, the customer stay should be limited to patent-specific issues in which the manufacturer is the best defendant because of its experience and knowledge of the technology and prior art. The customer, on the other hand, should remain free to argue issues specific to the customer, including various equitable and affirmative defenses, damages, and notice, all of which hinge on facts that lie exclusively in the customer’s knowledge.
3. Defining the “Covered Customer.” One of the most critical aspects of the customer stay provision is the definition of a “covered customer,” i.e., a customer who is able to take advantage of the stay provision. AIPLA, for example, has emphasized that a customer stay provision must be “appropriately crafted and not so overbroad that genuine infringers receive protection intended for the innocent.”41
In their current state, the Innovation Act and PTIA fail to meet the AIPLA standard, as both contain overly broad definitions for “covered customers.” Former USPTO Director David Kappos emphasized this fact when testifying before the House Committee on the Judiciary:
[A]s currently written the stay provision permits all parties in the product channel downstream of the first component part maker to escape infringement liability, including large commercial actors such as manufacturers combining procured components into value-added completed devices, as well as assemblers, and others not operating in the roles of “mere retailers” or “mere end users”, and certainly not operating in the roles of “mom and pop shops”. This unnecessarily devalues intellectual property and thus innovation by artificially limiting or even eliminating legitimate patentees’ ability to protect their innovations. It also may leave an American innovator with no infringer at all to pursue where infringing manufacturers are located outside the reach of the US courts, such as overseas, or lack adequate assets to answer for infringement.42
As recognized by Kappos, the Innovation Act and PTIA create a significant liability gap.43 Specifically, the definition of a covered customer is broad enough to include not only end users, but also value-added resellers and other downstream manufacturers.44 These entities typically do not suffer from an end user or retailer’s lack of experience, knowledge, and resources and have a much stronger incentive to defend a patent infringement lawsuit. As a result, permitting all but an original equipment manufacturer (OEM)45 to benefit from a customer stay provision is unnecessary, and the customer stay provision ought to be limited to covering retailers, service providers, end users, and the like. To assist in drawing this line, entities that materially alter or incorporate the covered product into another product or process should be excluded from the customer stay provision.
D. Changing Court Rules or Changing the Patent Statute?
Although the above recommendations are based on customer stay provisions in proposed legislation, the question remains whether a legislative approach provides the best solution to the customer suit problem. Congress undoubtedly has authority to make and amend the patent laws. However, some members of the Judiciary have been outspoken in their view that the increase in NPE suits is a procedural issue in the courts rather than one of substantive patent law, and, thus, the proposed solutions fall outside the scope of Congress’s power.46
If the NPE problem is characterized as a procedural problem, remedying the increase in NPE suits would not only be more practical for the Judiciary to address but would also better conform to existing laws. For example, the Rules Enabling Act gives the Judiciary the “power to prescribe general rules of practice and procedure and rules of evidence for cases in the United States district courts (including proceedings before magistrate judges thereof) and courts of appeals.”47 Further, when considering customer stays specifically, 28 U.S.C. § 1657 provides “each court of the United States shall determine the order in which civil actions are heard and determined.”48
In light of these laws, a rule-based customer stay initiated by the Judicial Conference may be more appropriate than a statutory solution by Congress. Not only would a rule-based stay conform more closely with existing law regarding control of procedural matters within the courts, it would avoid a potential clash between the Article I and Article III responsibilities of the Legislature and the Courts.49 That said, the Judicial Conference is not immune to the problems and pitfalls of crafting an effective customer stay provision. As a result, the recommendations in this Article apply equally to a rule-based approach.
IV. REVIEW OF THE PROPOSED SOLUTION
The high stakes involved in patent litigation50 will most certainly continue to encourage patent practitioners to seek out loopholes and gaps in the law. As a result, a mechanism for review and evaluation of the customer stay’s effectiveness within a given time period should be incorporated in the legislation. Of course, Congress has the authority to consider legislative adjustments at any point in time, but building a reporting mechanism into the law may be advantageous. A mandatory review would encourage Congress to make a further and perhaps more informed judgment five years down the road after first receiving a report from an administrative body or other entity charged with issuing an evaluation report and recommendation.
While the Authors question the wisdom of a reporting procedure, such procedures have become more popular in recent legislation. For example, the new America Invents Act requires a PTO study and a corresponding report to Congress four years after its enactment detailing the effectiveness of new business method procedures.51 In the event that such a procedure is adopted, the question remains as to who should conduct such a review. Given its central role in the patent system, the USPTO may seem like an obvious choice to oversee changes to patent law. However, the USPTO’s experience is in the technical and prosecutorial aspects of the patent system, whereas the customer stay provision is litigation-specific. As a result, the Judicial Conference of the United States or the Department of Justice may be better suited to conduct the necessary evaluation and report.
Regardless of whether a genuine NPE crisis in patent litigation exists, the customer suit problem is real and should be addressed. Whether implemented as legislation or through procedural rules, a customer stay provision offers an effective means of curbing customer suits. Although a basic framework is under consideration, currently proposed legislation is problematic in the way it defines who can take advantage of customer stays, how a customer and manufacturer suit need be related, and what effects a suit involving an intervening participant in a given channel of trade would have on the customer. By addressing these issues, the customer stay provision offers promise as an effective tool to combat exploitation of the high costs of patent litigation against otherwise innocent customers and end users.