LONDON’s technology sector is booming. Driven by big venture capital investments (tech firms attracted a record $1bn in the first nine months of 2014), and encompassing everything from finance to fashion, it is one of our greatest recent success stories. But this nascent sector also faces a worrying potential threat. A fresh menace to the workings of efficient markets is rapidly gripping the global tech industry, and it threatens to stifle innovation, raise prices, and constrain choice for consumers across the globe. The threat has been dubbed “patent privateering” and its impact on effective competition is already alarming.
Patent privateering refers to the practice whereby corporations wanting to defend their market share enter into private agreements with patent assertion entities (PAEs), or patent trolls as they are more commonly dubbed. These PAEs are effectively special purpose vehicles with no manufacturing capabilities; they are created to enforce patent rights and sue people. The more, the better.
Though the activity is shrouded in secrecy, there are signs that British courts are being targeted in a forum-shopping exercise by global monopolists, who are using this technique to reduce competition and innovation in the tech sector.
The process works along these lines: Company A and Company B have agreements to license a specified number of patents from each other to create a product. What Company B does not know is that Company A has a private agreement with Company C (a privateer) to hold certain patents that are essential to the production of the product Company B is creating. Once the product is in the market, the privateer, Company C, threatens to sue Company B. Since it may cost Company B anything up to $6m to defend itself in the US courts, most companies opt to settle. Then, Company A benefits from a large share of the proceeds collected by Company C. Such behaviour cramps competition and damages the end consumer – big time.
This cynical form of economic rent-seeking is becoming more and more widespread. Patent trolls are now estimated to add a staggering annual burden of $29bn onto US consumers alone.
Incumbents with a market share to defend are tempted to set up patent trolls in order to avoid counter suits, which would risk their own asset base as well as attract unwelcome publicity and potential reputational damage.
Thankfully, media reports have begun to shine light on these practices, though there are worrying signs that this is no longer a largely US phenomenon. These developments risk turning patents into a tool of litigation rather than innovation. Abuse of the patents principle runs counter to their original intent, which was to be a set of exclusive rights granted by the government of a sovereign state to spur innovation and provide entrepreneurs with a reasonable return for their innovative research, collected on a fair, reasonable, and non-discriminatory (what lawyers term FRAND) basis.
In the software industry, over 100,000 patents are filed each year. Many are for innovations that are not particularly novel and which are likely to be independently invented by other IT engineers. In practice, it is often impossible for a software firm to know that it is not infringing on an existing patent. In the US, where wilful infringement triggers treble damages if proved in court, software developers have a powerful incentive not to conduct a patent search.
Competition watchdogs need to cast a careful eye on these worrying developments. Already in the US, the Federal Trade Commission (FTC) has begun to collect information on trolls’ corporate structures, their portfolios of patents, and the way in which they acquire and enforce them. Congress is also considering legislation aimed at outlawing deceptive patent demand letters and granting the FTC civil penalty authority to tackle this threat to consumers.
In Europe, regulators have yet to really tackle the threat posed by patent privateers. It is true that the issue isn’t yet as pressing. But as Robert Harris, a professor at the University of California, Berkeley points out, “given the harm to competition that patent entity sponsored privateering poses, there are important roles for anti-trust authorities: blocking potentially anti-competitive patent transfers and bringing enforcement actions against anti-competitive conduct by patent entity sponsored PAEs”.
The courts in England, it seems, will be the first in Europe to evaluate and rule on patent privateers. US courts have already suffered from bruising judicial battles that have proved a perfect case study of how rent-seeking through the courts can harm the effective functioning of a dynamic market.
The hope is that we do not have to learn the lesson the hard way, as the Americans have done. It’s about time our regulators woke up to the threat posed by the growing ranks of rent-seeking patent trolls.