Who Are Patent Trolls & How Do They Work?

The United States Patent and Trademark Office (USPTO) defines a patent as a license granted by a government for an invention, be it a new process, manufactured article, or a useful and new improvement (utility patent), original ornamental design (design patent), or a new and distinct variety of a plant (plant patent). It is often issued for 20 years from the date of filing, which gives the patent holder a good chunk of time to exclusively produce the patented product, and also to pursue claims against others that infringe on their patent.

USPTO defines the right granted by a patent as the “right to exclude others from making, using, offering for sale, or selling” the invention in the US or “importing” the invention into the US. And it is this “right to exclude others” that has been exploited by patent trolls for decades for their financial benefit.

Patent trolls, more formally referred to as Non-Practicing Entities (NPEs) or Patent Assertion Entities (PAEs), are companies that make money on patent-infringement lawsuits. Unlike operating companies that use their patents to produce and sell their product, patent trolls often acquire patents cheaply from bankrupt companies and do not use those patents in operations, but rather charge licensing fees to other businesses and individuals that appear to infringe upon a patent that they own. They will typically threaten these businesses with a lawsuit if they do not comply.

Licensing fees can range anywhere from tens of thousands to hundreds of thousands of dollars, whereas patent lawsuits can cost in the millions of dollars. Hence, many companies prefer to settle, even if they believe there to be no patent infringement. Incidents of patent troll litigation are more prevalent in the US than in Europe. Europe follows the “loser pays” practice, wherein the losing party in a lawsuit pays the legal fees of both parties. This discourages frivolous suits based on broad, low-quality patents. U.S. law, on the other hand, states that each party to a lawsuit must pay their share of legal fees.

Patent trolls are on a constant lookout for any existing technologies or new applications that might potentially infringe on their portfolio of patents. Once a potential infringement has been identified, the trolls go on to develop an attack plan. Often, it is the weakest and the most vulnerable in the target industry that are pursued, since an easy first win sets up a precedent that will determine future resistance on the part of others in the industry to pay licensing fees.  

Smaller targets, often mom-and-pop shops, receive demand letters full of legal jargon alleging patent infringement. Succumbing to these often-unfounded threats, many small business owners would rather pay to settle than to pursue the battle in court, which could divert considerable financial resources from their core research and operations. Settling may not, however, be the best solution even when it comes to monetary considerations. Patent trolls, sensing a ‘soft’ target, may set their path on multiple future claims, turning a short-term economic advantage of a one-time payoff into long-term funds drain from the target.

According to the RPX Corp’s (RPXC) "NPE Litigation Report," nearly 4,500 patent cases were filed in 2014. Of those, patent trolls were responsible for 2,791 cases, or 63% of the total, whereas actual operating companies filed only 1,667. The most popular regions for this kind of activity are the Eastern District of Texas and the District of Delaware, which together accounted for 70% of cases filed in 2014. The vast majority of patent-infringement lawsuits filed by patent trolls are in the software and mobile device sectors, with smaller private companies with revenues under $100 million being the primary target. The most litigious of all patent trolls in 2014 was Acacia Research Corp. (ACTG), operating from Newport Beach, Calif., with 257 active patent cases as of September 2014.

The disproportionate number of cases being heard in the East Texas court has become a focal point of a 2017 Supreme Court case. The case, TC Heartland LLC v. Kraft Foods Group Brands LLC, seeks to have the Court overrule the currently observed venue rules. TC Heartland, which was originally sued for patent infringement by Kraft (KHC) in Delaware, attempted to have the case transferred to Indiana, where the company is based. The lower courts denied its request, citing a 1990 decision from the U.S. Court of Appeals for the Federal Circuit. The decision in that case said patent case defendants could effectively be sued anywhere they do business. 

Now, TC Heartland is asking the Supreme Court to reinstate an older rule that features more restrictive venue guidelines, based on the argument that Congress didn't intend for recent changes in general venue rules to be extended to patent cases. Kraft argues that these changes should be upheld and applied to cases involving patent suits. A number of technology companies, including Intel (INTC), Adobe (ADBE), eBay (EBAY) and Oracle (ORCL), have joined an amicus brief filed in the case in support of TC Heartland's position, calling for the Court to enforce stricter rules on where patent lawsuits can be initiated. (Note: Investopedia's owner, IAC/InterActiveCorp., is one of the 41 companies on the list.)

After spiking near the end of 2015, 2016 saw a slight decline in patent-suit activity. The Eastern District of Texas remains a hotspot for this type of litigation, however, with approximately one in three patent-troll suits filed there in 2016. Clearly, there is still much money to be made in this practice. Smaller private technology companies in software and mobile device sectors are particularly vulnerable to patent lawsuits. One way to mitigate risks associated with patent-troll litigation is to hire patent-tracking companies on an annual-fee basis to acquire relevant and potentially problematic patents and rights in the market before patent trolls capitalize on those patents and use them against operating entities.