Patent Strategies and Tactics

McCarthy Tetrault lawyer George Takach wrote a good piece recently on approaches to the patent biz. His firm advises RIM, so we can trust they know a thing or two about the topic. They even have a blogging lawyer.

While having registered patents isn’t a requirement to enable you to raise venture capital or venture debt, it certainly demonstrates that your company is doing something arguably unique. Not a deal breaker, but for an early stage company it can be awfully important. We care about customer traction more than patents, but the VC world will justifiably grill you on it.

Here is George’s article:

Thinking Offensively

It is worth approaching patents both offensively and defensively. By the former I mean considering whether, or to what extent, your organization can derive value from pursuing your own patents.

If you are in a high tech business, you must give some consideration to building a patent portfolio, particularly if the bulk of your sales are in the US (which is the case with most Canadian tech companies). You simply cannot ignore that IBM files about 3,000 patents a year, and earns about US$1 billion from its patent licensing business.

A number of tech companies have become so enamoured of patents they have actually toned down, or eliminated altogether, the part of their business that makes and sells products, and instead they focus exclusively on R&D, patenting and licensing. Qualcomm is a good example in the US, ARM (whose technology resides in about 70% of the world’s cell phones) is a UK example, and in Canada Mosaid has done likewise.

Even if you do not go this far, you still have to think how far you need to go. And not merely to keep up with your American or European competitors. The new tech and other industry players from India and China are starting to flex their muscles. Huawei, a Chinese maker of telecoms equipment, now files about 2,500 patents a year. Another (much smaller) Chinese company, Netac Technology, has about 200 patents for USB memory devices and MP3 players. It recently sued Sony Electronics, claiming that one of Sony’s factories in China infringes Netac’s patents.

Whether you are a tech company, or a bank, or any other type of business, when you think about patents offensively (that is, in order to derive value from them), you will have second order tactical considerations, such as whether you apply for a fewer number of more robust, fulsome patents, or whether you go for volume (i.e.- a greater number of less sophisticated filings). It is generally conceded that only 5% of patents have serious commercial value, so deciding the approach to this question that makes sense for your organization is important.

Reacting Defensively

Big bones attract big dogs. At the end of 2004, Microsoft had about 6,000 issued patents, and another 10,000 pending. But at the same time it was the target of about 32 patent infringement lawsuits, and spends about $100 million a year on legal costs defending these claims.

This illustrates one of the very important rationales for building a patent portfolio: namely to have some of your own intellectual property currency with which to respond to a plaintiff’s patent claims, typically ultimately with a view to entering into some sort of revenue/cost neutral cross-licensing arrangement.

Responding to Demand Letters

Most patent fights do not start with a statement of claim. Invariably there is instead a demand letter, setting out the details of the claimant’s patents and explaining how they believe your particular product or process (or business method) infringes their patents. In order to respond, you’ll have to make a threshold determination: do you want to fight the claim in court, or get (and pay for) a license?

Before making this decision, you’ll want to know (among other things), what prior art your organization may have that could invalidate the claimant’s patents. But you’ll also want to diligence what other recipients of the same demand letter are paying by way of royalties. For example, often if you’re an early recipient of the letter (relative to others in your industry), you may be able to negotiate a very favourable royalty rate; in other words, the royalty rate increases as initial hold outs finally come on board the licensing bandwagon.

Licensing is by far the more common alternative. It is estimated that about $100 billion annually is paid globally for various intellectual property licenses. As to whether it makes sense in your case, one of your important questions will be the quantum demanded by the claimant (patent license royalties can range anywhere from .25% to 15%, depending on the industry and the strength of the underlying patents). The other key question is whether you will be able to pass this extra cost onto your customers.

Stealthy Treble Damages

Let me address one huge tactical trap for the unwary. Often you will receive a letter from a US patent holder that doesn’t actually demand anything, per se, but merely says, as a “courtesy”, that they are letting you know they have various issued patents (copies of which are enclosed with this strange letter), and wishing you a pleasant day. As the tone of the letter is quite neutral, seemingly merely informational and almost friendly, many business people merely ignore it, thinking they should focus exclusively on letters that make clear demands for payments.

This is a big mistake. What the seemingly innocuous letter is doing is putting you on notice of the actual details of the relevant patents held by the claimant. Why? Because under US patent law, if you continue to infringe the patent after having actual knowledge of it, you will be liable for treble damages (that is, calculate the “regular” damages, and then multiply that figure by three). So don’t blithely ignore this sneaky letter; rather, you need to get a US patent attorney’s opinion as to whether you infringe or not. If he or she says you do not, then the treble damages spectre falls away, but regular damages could still be awarded if the case went to court.

Like It or Not

A common reaction by business people to the above-noted patenting statistics and related litigation and licensing phenomenon is: “I do not like it, clearly the patent system is out of control and needs to be changed”. And indeed there are proposals floating around Washington to reform various aspects of the US patent system.

For the present time, however, such sentiment and proposed law reform, while interesting, should not cause business people to lose sight of the core reality: patents are a force to be reckoned with (both offensively and defensively), and a business ignores them at its peril.

Important Infringement Indemnities

The patent licensing/litigation explosion also has a contractual dimension. Most agreements for the supply of high tech products or services include a provision whereby the supplier gives an indemnity to the customer in respect of intellectual property claims that may be brought against the customer by a third party by reason of the customer’s use of the supplier’s product or service. For reasons made clear by these three columns on patents, in today’s digital world, this indemnity provision has assumed great importance for buyers of products and services.

Not surprisingly, some vendors are cutting back – sometimes dramatically – the scope of coverage of these clauses. Certain suppliers of high tech products, for example, exclude patents altogether from the scope of the provision, limiting it to simply copyrights and trade secrets. Or if patents are covered, the provision might be limited only to those patents that have issued as of the date of the agreement, or the clause may be circumscribed only to US patents (leaving the customer to fend for itself in any other jurisdiction in the world).

Another limiting approach is to cover all patents except certain specific ones that are known to be extremely problematic (that is, they belong to owners that are actively pursuing their enforcement). In all these cases, users of technology confronted by these new-fangled variations on the intellectual property indemnity need to fully consider their ramifications before signing on the dotted line, because more than ever, the odds are pretty good that the IP indemnity clause may come into play at some point.

MRM