The report states
Patent assertion entities (PAEs) are businesses that acquire patents from third parties and seek to generate revenue by asserting them against alleged infringers. PAEs monetize their patents primarily through licensing negotiations with alleged infringers, infringement litigation, or both. In other words, PAEs do not rely on producing, manufacturing, or selling goods. When negotiating, a PAE’s objective is to enter into a royalty-bearing or lump-sum license. When litigating, to generate any revenue, a PAE must either settle with the defendant or ultimately prevail in litigation and obtain relief from the court.
In acquiring and then asserting patents, PAEs target individuals and businesses that already use (at least allegedly) the patented technology. PAE activity therefore results in what often are referred to as ex post patent transactions because any patent license or settlement occurs after someone has developed or marketed the product at issue. This contrasts with ex ante patent transactions in which the technology and related patent rights transfer from an inventor to a manufacturer before the product is developed and marketed. The fact that PAE activity facilitates ex post, as opposed to ex ante, patent transactions has raised policy questions about the role of PAEs in promoting innovation and economic growth.
To begin answering these questions, researchers at several government agencies and academic institutions have studied PAE business models to evaluate the specific impact on patent litigation.
These studies have focused on publicly observable litigation behavior and relied on publicly available litigation data. A deeper understanding of PAE business models, however, requires consideration of behavior that is not publicly observable or available, such as how the entities structure and organize themselves, or their confidential acquisition and licensing terms and data.
The Federal Trade Commission has authority under Section 6(b) of the Federal Trade Commission Act to collect confidential business information and conduct industry studies. We used our authority to study PAE acquisition, litigation, and licensing practices because more data on and analysis of the non-public aspects of PAE business models can enhance the quality of the policy dialogue. Furthermore, to better understand how PAE business models compare with other business models that utilize patent licensing, we conducted a more specific study of the wireless chipset sector, in which not only PAEs, but other non-practicing entities (NPEs) and wireless chipset manufacturers (Wireless Manufacturers) assert wireless-technology patents.
In the general PAE study, the FTC analyzed information from 22 Responding PAEs and over 2,500 of both their Affiliates and other related entities. As explained below, the FTC observed two distinct PAE business models: Portfolio PAEs and Litigation PAEs. Table A.1 provides an overview of the various categories of PAEs discussed in this Report.
We examined the practices of each of these respondents across an almost six-year period between January 2009 and mid-September 2014. Of the related entities, 327 engaged in active assertion behavior, namely, sending demands, suing for patent infringement, or licensing patents, during the study period. In the wireless chipset case study, the FTC compared the behavior of PAEs active in the wireless chipset sector with eight manufacturers and five NPEs that asserted patents in this sector. This report describes our major findings from the study and makes recommendations for future reform.It states key findings -
The FTC observed two distinct PAE business models: Portfolio PAEs and Litigation PAEs. From the information and data collected from the PAE respondents, we observed two distinct PAE business models for generating revenue through patent assertion: Portfolio PAEs and Litigation PAEs. Within each business model, Study PAE behavior was relatively homogeneous.
Portfolio PAEs: Portfolio PAEs negotiated licenses covering large portfolios, often containing hundreds or thousands of patents, frequently without first suing the alleged infringer. The value of these licenses was typically in the millions of dollars. Although Portfolio PAEs accounted for only 9% of the reported licenses in the study, they generated 80% of the reported revenue, or approximately $3.2 billion. Portfolio PAEs typically funded their initial patent acquisitions through capital raised from investors, including institutional investors or manufacturing firms.
Litigation PAEs: Litigation PAEs typically sued potential licensees and settled shortly afterward by entering into license agreements with defendants covering small portfolios, often containing fewer than ten patents. The licenses typically yielded total royalties of less than $300,000. According to one estimate, $300,000 approximates the lower bound of early-stage litigation costs of defending a patent infringement suit. Given the relatively low dollar amounts of the licenses, the behavior of Litigation PAEs is consistent with nuisance litigation. For each separate patent portfolio that they acquired, Litigation PAEs characteristically created a new affiliate entity, which often held ten patents or less. They generally operated with little or no working capital and relied on agreements to share future revenue with patent sellers to fund their businesses. Litigation PAEs filed 96% of the cases in the study and accounted for 91% of the reported licenses, but only 20% of the reported revenue, or approximately $800 million.
Portfolio PAE licenses generated total royalties that were much larger, on average, than those of Litigation PAE licenses. There was little overlap in the royalties generated by Litigation PAE and Portfolio PAE licenses. Seventy-seven percent of Litigation PAE licenses generated royalties of less than $300,000 per license, and 94% generated royalties of less than $1 million per license. By contrast, 65% of Portfolio PAE licenses generated royalties of greater than $1 million per license, and 10% generated royalties of greater than $50 million per license. The FTC did not observe demand-letter campaigns that, on their own, generated low-revenue licenses. In addition to negotiating licenses and initiating infringement litigation, PAEs may assert their patents by demanding that a target take a license from them. Often these demands take the form of a “demand letter.”
The FTC did not observe Study PAEs successfully generating low-revenue licenses by sending demands, but not suing the target. This suggests that demand-letter reform, on its own, would not fully address the potential negative repercussions of PAE activity. Instead, most licenses in the sample followed a patent infringement suit against the alleged infringer. Consistent with the fact that Litigation PAEs accounted for 91% of reported licenses, patent infringement suits against the eventual licensee preceded 87% of the licenses in the sample. Litigation preceded 93% of Litigation PAE licenses, but just 29% of Portfolio PAE licenses. Because a significant portion of observed PAE activity passed through the courthouse doors, further analyses of publicly available litigation data likely would be beneficial.
Study PAEs focused on acquiring and asserting Information and Communication Technology (ICT) patents. Of all the patents held by PAEs in the FTC’s study, 88% fell under the Computers and Communications or Other Electrical & Electronic technology categories, and more than 75% of the Study PAEs’ overall holdings were software-related patents.
Although Study PAEs overwhelmingly held ICT and software patents, they asserted those patents against firms in a broad range of industries, including “Retail Trade.” More than 17% of demand recipients, 10% of litigation defendants, and 13% of licensees identified in the study operated in the “Retail Trade” industry, which includes both store retailers that operate fixed point-of-sale operations and non-store retailers, such as Internet merchants that directly sell products.10 Given that most of the patents asserted by Study PAEs were ICT patents, the presence of retailers among the targets of assertion activity in the study suggests that Study PAEs asserted their patents not only against manufacturers of the accused products, but also against firms that were end-users of the products. This finding supports anecdotal evidence that end-users are frequently PAE targets.
Although most Study PAE targets had just one encounter with any Study PAE, a small number of entities were frequent targets of Study PAE activity. Within each category of assertion behavior (demand, litigation, and licensing), most of the observed activity involved a single instance of assertion by any Study PAE against a target. For example, during the study period, 73% of the assertion targets were defendants in only one lawsuit brought by any of the 256 Study PAEs that filed infringement suits, and 13% of the assertion targets were defendants in two lawsuits. Nevertheless, a small number of firms reported multiple encounters with Study PAEs. Of the firms that received demands from Study PAEs, 2% received more than five demands, and one firm received 17 demands. Of the firms that reported licenses with Study PAEs, 2% had licenses with more than nine separate Study PAEs.
Study PAEs disproportionately asserted patents against a relatively small number of firms. These firms most frequently operated in the “Computer & Electronic Product Manufacturing” industry. Indeed, firms in the “Computer & Electronic Product Manufacturing” industry accounted for more than half of the top 25 firms that (1) received the largest number of demands from Study PAEs, (2) were sued most frequently by Study PAEs, or (3) paid the largest royalties to Study PAEs. In addition, while not necessarily receiving the most demands, the top 25 firms that paid the highest amount of license royalties to Study PAEs accounted for 69% of the royalties observed in the study.
In the wireless chipset sector, Litigation PAEs and Wireless Manufacturers asserted patents differently. In the Wireless Case Study, the FTC examined the patent assertion activities of PAEs, NPEs, and manufacturers in the wireless chipset sector to understand better how different business models might affect assertion behavior in the same technological space. We observed that Wireless Manufacturers sent demand letters before executing licenses, while Litigation PAEs sued before licensing their patents. Wireless Manufacturers and NPEs also sent nearly three times as many demand letters as all of the Study PAEs combined. Litigation PAEs brought nearly two-and-a-half times as many patent infringement cases involving wireless patents as Wireless Manufacturers (which collectively accounted for approximately 90% of worldwide chipset sales), NPEs, and Portfolio PAEs combined.
Wireless Manufacturer and Litigation PAE license characteristics also differed markedly. Wireless Manufacturer licenses frequently included field-of-use restrictions, cross-licenses, and complicated payment terms, whereas Litigation PAE licenses involved simple lump-sum payments with few restrictions, if any. Portfolio PAE and NPE license characteristics fell between these two extremes.
A number of scholars have expressed concerns that, because PAEs likely face lower costs and fewer risks of asserting their patents than other patent holders, such as manufacturers, PAEs more aggressively assert their patents. In particular, these scholars are concerned that lower litigation costs may allow PAEs to obtain higher royalties than a manufacturer or NPE would receive. In the Wireless Case Study, the FTC found that Study PAEs were more likely to assert their patents through litigation than were Wireless Manufacturers. For example, 30% of Portfolio PAE wireless patent licenses and nearly 90% of Litigation PAE wireless patent licenses resulted from litigation, while only 1% of Wireless Manufacturer wireless patent licenses resulted from litigation. The FTC, however, has not attempted to determine if the royalties received by Study PAEs were higher or lower than those that the original assignees of the licensed patents could have earned. The FTC did not have the data to estimate reliably the royalties the original assignee would have received for the patents ultimately licensed by a Study PAE.
Study PAEs had diverse and heterogeneous data-keeping practices. As a result, the FTC does not report how much revenue PAEs shared with others, including independent inventors, or the costs of assertion activity. The FTC sought to evaluate the role of PAE activity in promoting patent monetization for inventors and innovation as part of its study. Towards that end, the FTC requested that Responding PAEs provide detailed data describing how they shared licensing revenue with outside parties and their costs of patent assertion. Responding PAEs used different methods to maintain information describing their revenue sharing and costs, however, which prevented any meaningful comparison of the degree of revenue sharing by PAEs or their assertion costs.
For example, some Responding PAEs viewed payments to outside counsel as a cost of patent assertion, but others viewed such payments as revenue sharing (counsel often received a fixed proportion of licensing royalties). Moreover, the majority of Responding PAEs did not maintain information on assertion costs, and only a few Responding PAEs provided such data at either the Affiliate level or assertion campaign level.14 For these reasons, we did not analyze either the proportion of licensing revenue that they shared with outside parties, or the costs of patent assertion. Due to this limited data, this report does not address the efficiency of PAE business models.
Recommendations for Legislative and Judicial Reform
As observed in the study, infringement lawsuits filed against targets played a key role in the viability and success of the Litigation PAE business model. Ninety-three percent of reported Litigation PAE licenses followed a lawsuit against the eventual licensee and 77% were valued at less than the estimated cost of defending a patent lawsuit through the end of discovery—a threshold below which litigation settlements might be considered nuisance value. In addition, when licenses followed litigation, those litigations tended to settle early; of the cases that settled, 34% did so within six months of filing, 66% within one year, and 83% within 18 months. Although Litigation PAEs generated a minority of the reported PAE licensing revenues in the study, they accounted for the vast majority of total lawsuits filed.
The FTC recognizes that infringement litigation plays an important role in protecting patent rights, and that a robust judicial system promotes respect for the patent laws. Nuisance infringement litigation, however, can tax judicial resources and divert attention away from productive business behavior. With this balance in mind, the FTC proposes reforms to: 1) address discovery burden and cost asymmetries in PAE litigation; 2) provide the courts and defendants with more information about the plaintiffs that have filed infringement lawsuits; 3) streamline multiple cases brought against defendants on the same theories of infringement; and 4) provide sufficient notice of these infringement theories as courts continue to develop heightened pleading requirements for patent cases.
Develop rules and case management practices to address discovery burden and cost asymmetries in PAE litigation. In civil lawsuits, plaintiffs and defendants exchange information relevant to the litigation through disclosures and responses to discovery requests. The Federal Judicial Center notes that discovery in patent litigation “can be exhaustive and exhausting for a variety of reasons,” including broad claims and defenses which require inquiry into product development and financial records, special issues that arise with willfulness and inequitable conduct claims, and “potentially consequential but unpredictable outcome[s]” that can lead to extensive discovery requests and lack of compromise.
Because PAEs do not invent, develop, or manufacture products incorporating their patented technology, they generally have less discoverable information than the party accused of infringement
They also are not subject to countersuit for patent infringement, and therefore do not face potential discovery relating to infringement counterclaims. A PAE may thus be able to subject a defendant to exhaustive discovery requests while itself facing a relatively light discovery burden. This asymmetry in discovery burden can give PAEs an advantage in litigation. As discussed above, Litigation PAEs settled 66% of their cases within 12 months, and settlements frequently involved lump-sum license payments valued at less than $300,000. The American Intellectual Property Law Association (AIPLA), which periodically surveys the costs of patent litigation, recently reported that defending an NPE patent lawsuit through the end of discovery costs between $300,000 and $2.5 million, depending on the amount in controversy. By this estimate, 77% of Litigation PAEs’ settlements fell below a de facto benchmark for the nuisance cost of litigation. This suggests that discovery costs, and not the technological value of the patent, may set the benchmark for settlement value in Litigation PAE cases.
Because defendants frequently paid less than the estimated value of discovery costs to settle litigation with Study PAEs, and because there is asymmetry in discovery burden between PAE plaintiffs and defendants, Congress, the Judicial Conference of the United States, and individual courts should promote case management practices that take these costs and asymmetries into account. One step toward achieving this goal would be to amend Federal Rule of Civil Procedure 26, which addresses discovery in civil actions, in a way that helps balance these relative burdens. Rule 26 requires parties to meet and confer to discuss, among other things, a plan for discovery. Early disclosure of asserted claims and infringement and invalidity contentions in PAE litigation would help to balance the asymmetries of plaintiff and defendant-side discovery costs. Likewise, measures that would limit discovery before preliminary motions together with provisions to ensure that such motions are decided in a timely manner would help alleviate the asymmetry problem. Furthermore, early disclosure of damages theories would flag potential legal issues for summary judgment motions and provide more information for settlement discussions. In general, any measures that reduce discovery burden and costs while ensuring discovery of information appropriate to the case should be considered.
Amend Federal Rule of Civil Procedure 7.1 to reach a broader range of non-party interested entities or persons. Federal Rule of Civil Procedure 7.1 requires all nongovernmental corporate parties to identify “any parent corporation and any publicly held corporation owning 10% or more of its stock” in its “first appearance, pleading, petition, motion, response, or other request addressed to the court.” The purpose of the rule is to “reach a majority of the circumstances that are likely to call for [judicial] disqualification on the basis of financial information that a judge may not know or recollect.” The FTC observed significant variation in how multi-affiliate Litigation PAEs organized their affiliate companies, many of which existing Rule 7.1 would not cover. To provide defendants and the judiciary with a better understanding of financial relationships relating to firms that may appear in the courtroom, Congress and the Judicial Conference should expand the reportable relationships under Rule 7.1.
Establish procedures encouraging courts to stay a PAE’s infringement action against a customer or end-user, where the PAE has also sued the manufacturer of the accused product under the same theory of infringement. The FTC observed that a significant proportion of PAE targets in the study did not appear to manufacture the allegedly infringing product. For example, Litigation PAEs filed over 15% of their cases against defendants in the “Retail Trade” industry. The Patent Act allows a patent holder to recover from anyone who “uses” the patented invention. Nevertheless, simultaneous litigation by a PAE against a manufacturer and its customers on the same theory of infringement can impose unnecessary judicial and private costs. Should the patent be invalidated in one case, for example, it would make further litigation in the other cases unnecessary. The manufacturer of an accused product typically has a much better understanding of the disputed technology and thus typically is in a better position to defend against the infringement suit than is a customer or retailer. And it is also more likely to have discoverable evidence because it produces the accused product.
Accordingly, to address situations where a PAE sues a manufacturer and its customers on the same theory of infringement, Congress and the Judicial Conference should enact provisions that encourage a district court to stay actions against end-users until the manufacturer suit has been resolved.
As courts continue to address the “plausibility” of pleadings in patent cases, ensure that patent infringement complaints provide sufficient notice to accused infringers. Until the end of 2015, a patent holder could file a complaint in district court by making simple allegations regarding its patent ownership and the defendant’s infringement. The patent holder did not need to identify any claims that were allegedly infringed, or list any accused products. This standard, based on a federal form for pleading patent infringement, applied to all of the infringement claims made by Study PAEs during the FTC’s study period.
In December 2015, however, an amendment to the Federal Rules of Civil Procedure abrogated the use of this form for patent cases. Patent holders, following the pleading standard articulated by the Supreme Court for civil cases generally, now must plead factual allegations that make infringement “plausible.” Because Litigation PAEs generate licensing revenue primarily through litigation, requiring more particularity in a complaint can provide defendants with more information with which to evaluate the nature and scope of their accused infringement. As the courts continue to develop the plausibility standard in patent cases, they should continue to consider the benefits of pleadings that provide sufficient notice to accused infringers.The FTC concludes
The FTC took its first in-depth look at PAE activity in the hearings leading up to its 2011 report examining technology markets and patent markets: The Evolving IP Marketplace: Aligning Patent Notice and Remedies with Competition. As the Commission recognized then, consistent with our earlier examinations of patent policy, the patent system makes important contributions to innovation, consumer welfare, and U.S. prosperity, in part because of the patent holder’s right to exclude.
Further investigation of the PAE business model, including a workshop in 2012,33 led the Commission to initiate this study—the first use of its Section 6(b) authority to investigate transactions in the intellectual property marketplace. The research presented in this report uses both public and non-public information to shed new light on PAE business models, including detailed data describing PAE assertion behavior and patent holdings.
Based on the overall findings of this study and consistent with the FTC’s history of recommending improvements to patent law to facilitate the benefits of patent rights, while minimizing practices that can “discourag[e] follow-on innovation, prevent competition, and rais[e] prices through unnecessary litigation and licensing,” the FTC recommends that policymakers address PAE litigation asymmetries through procedural and substantive reform.