In the early 2010s the growth of Patent Trolls and frivolous patent litigation was top of mind for tech executives and entrepreneurs across America. Demands were made for Congress to draft effective anti-troll legislation, but most bills were stalled and the few enacted did little to help.
Faced with federal inaction, 32 different state assemblies stepped up and passed anti-troll laws. Now, five years later, public discourse might have died down but the data on the efficacy of these laws is in, bringing up new questions and ideas on how to tackle the still pertinent threat of Patent Trolls.
We conducted an interview with Ian Appel of Boston College, Joan Farre-Mensa of the University of Illinois at Chicago, and Elena Simintzi of UNC Kenan-Flagler to discuss their paper, “Patent Trolls and Startup Employment.” The paper, forthcoming in the Journal of Financial Economics, is the first comprehensive academic study to investigate the efficacy of state-level anti-troll laws.
Note that Ian, Joan, and Elena presented their responses as singular, combined statements and will be referred to as ‘Research Team.’
Venture First: For our readers that are unfamiliar, what is a non-practicing entity? Are all NPEs Patent Trolls?
Research Team: In the patent context, a non-practicing entity (NPE) is a legal organization (e.g., an LLC or a corporation) that holds a substantial portfolio of patents but it does not directly develop or use the patented technologies.
It is important to emphasize that not all NPEs are necessarily “bad” actors (i.e., not all NPEs behave as what is usually referred to as Patent Trolls). For instance, some scholars and public commentators believe that at least some NPEs play a useful intermediary role that makes it easier for small inventors to enforce and monetize their patents.[1]
Venture First: So there’s useful NPEs in the business of legitimate IP licensing and then there’s bad actor NPEs in the business of frivolous litigation. From what we’ve seen, Patent Trolls often possess broadly applicable patents and make litigation threats that are unlikely to make it through court. Patent Trolls seem to be betting on startups being unable to afford the legal fees and instead opting for settlements.
It’s clear how Patent Trolls are a scary threat, especially to those with minimal legal means, but what do they entail for the broader economy and America’s capacity to innovate?
Research Team: The economics and finance literature has shown that startups are a key driver of job creation and innovation in the U.S.[2] When startups need to devote their scarce resources—both money and time—to defend themselves from frivolous threats of litigation instead of to develop their products and ideas, this can threaten startups’ ability to grow, create jobs, and innovate, which in turn threatens the vitality of the U.S. economy.
Venture First: What do anti-troll laws typically consist of? This doesn’t seem to be an easy problem to solve seeing as Patent Trolls are operating within the bounds of current laws.
Research Team: The goal of anti-troll laws is to protect local businesses from frivolous patent infringement claims in order to reduce the costs that such claims, particularly those that are sent in mass to small businesses, impose on the state economies. The laws have been framed as consumer protection laws, thereby sidestepping the fact that most aspects of patent law are a federal matter.
To get a sense of the content of these laws, it is helpful to focus on the Vermont anti-troll law, which was the first state anti-troll law and has served as a model for other states. The Vermont law seeks to change the cost benefit analysis of patent trolls in Vermont by making it more costly to send out patent demand letters in “bad faith.” To determine whether a patent infringement claim is made in “bad faith,” Vermont courts can consider whether “[p]rior to sending the demand letter, the person fails to conduct an analysis comparing the claims in the patent to the target’s products, services, and technology”; “[t]he demand letter demands payment of a license fee or response within an unreasonably short period of time”; “[t]he person offers to license the patent for an amount that is not based on a reasonable estimate of the value of the license”; or “[t]he claim or assertion of patent infringement is meritless …” or “deceptive.” The law establishes that if a court finds that a Vermont firm has been the target of bad faith patent infringement assertions, the court may award it the following remedies: “(1) equitable relief; (2) damages; (3) costs and fees, including reasonable attorney’s fees; and (4) exemplary damages in an amount equal to $50,000.00 or three times the total of damages, costs, and fees, whichever is greater.” To minimize the legal burden imposed on firms that are targeted by Patent Trolls, the law allows the state’s Attorney General to initiate legal actions against Trolls.[3]
Venture First: So to beat a Troll, you have to remove the financial incentives to become one. We find the idea of saddling trolls with both party’s legal costs particularly interesting. Previously, startups in Vermont with minimal legal means would be forced to settle with a Troll, even if it’s clear the lawsuit is baseless. But now they can take on frivolous lawsuits knowing their legal costs will be repaid.
Moving on to results now, one of the key takeaways from your study was when states adopted anti-troll laws, they saw on average a 4.4% increase in high-tech startup employment. What other benefits are states seeing from protecting startups from frivolous patent demands?
Research Team: Other benefits include higher incentives to innovate and a larger supply of capital to fund those innovations. Consistent with these benefits, our study shows that anti-troll laws are associated with an increase in patenting as well as in the number of firms raising early-stage venture capital and using patents as collateral for loans. These results suggest that, by reducing the risk posed by frivolous patent demands, state anti-troll laws make it more profitable to invest in high-tech startups. As a result, startups in states that pass anti-troll laws have an easier time raising capital from VCs and other investors.
Venture First: We imagine many of our readers will want to know how you managed to attribute all these benefits to legislation. Could you touch briefly on how you managed to control for potentially confounding factors?
Research Team: Controlling for potentially confounding factors is of utmost importance to ensure that we are truly capturing the effects of anti-troll laws. Our main approach to deal with confounding factors is a so-called “difference-in-differences” strategy. The idea is to compare the performance of states that have passed an anti-troll law to that of states that have not (but may still do so in the future). The advantage of this approach is that it ensures that we do not mistakenly attribute changes in performance that are due to overall macroeconomic trends to the anti-troll laws.
For instance, Vermont passed an anti-troll law in May 2013, and subsequently startup employment went up in Vermont. However, if startup employment also increased in other states without anti-troll laws at the same time by the same relative amount, our approach would not attribute the increase in startup employment in Vermont to its anti-troll law. We would only attribute to the law any increase in startup employment that is unique to Vermont (and to the other states that passed anti-troll laws).
In addition to using this difference-in-differences methodology, we have also used several complementary approaches to further control for confounding factors. This includes making sure that there are no additional laws that were passed at the same time as the anti-troll laws that could be driving our results and checking that, prior to the passage of the laws, states that passed anti-troll laws were on similar economic trends as those that did not. Finally, we also show that states that pass an anti-troll law experience a decrease in Google searches for “patent trolls” and “patent attorney”—a prediction that is likely unique to anti-troll laws and not shared by other potential confounds.
Venture First: If the benefits are clear, and reference laws are in existence, why are we not seeing this happen at the federal level? After all, the federal government is the ultimate arbiter of intellectual claims. Could it be because state laws were made possible by grassroots movements to benefit startups and laws like these are less likely to benefit the cash-filled corporations lobbying DC?
Research Team: There have been a number of attempts at the federal level to pass federal anti-troll legislation similar to the laws passed by many U.S. states.[4] However, at least so far, these attempts have not been successful. It is true that anti-troll laws benefit mostly startups, which tend not to have much “lobbying muscle.” But we have not specifically examined whether corporate lobbying in DC (or lack thereof) is the reason why no federal anti-troll law has been adopted.
One case we have looked at is that of California. An anti-troll law was introduced in the California State Senate in February 2015 (S.B. 681). However, the bill was not passed despite having the support of the Silicon Valley Leadership Group, which includes leading tech companies and investors such as Facebook, Google, HP, Kleiner Perkins Caufield & Bryers, Silicon Valley Bank, SV Angel, and Tesla Motors. The office of State Senator Hill, who introduced S.B. 681, wrote to us in an e-mail that “the original bill had support and no opposition but the Chair of the Senate Judiciary Committee wanted amendments that our supporters didn’t like.” Ultimately, legislators could not agree on a text that all key senators thought would deter “fraudulent patent infringement claim letters” without having “a chilling effect on legitimate communications between small innovators trying to engage in coordination, development and licensing communications with larger businesses.”
We conjecture that similar disagreements might also help explain Congress’s inability to pass anti-troll legislation at the federal level.
Venture First: To put ourselves in the shoes of a California senator, we’d see that there are patent demands that are clearly frivolous, and patent demands that are clearly not. It’d be the grey-zones that would scare us. We’d fear that dealing with these grey-zone situations with an imperfect law would result in an adverse decrease in legitimate patent demands over time.
Based on how anti-troll laws have performed in other states, are those fears warranted?
Research Team: You are right that there is a fair amount of grey-zone to be found. The way how most state anti-troll laws are written, they allow substantial discretion for courts to determine what kind of behavior is punishable. For instance, as mentioned above, the Vermont anti-troll law allows courts to consider whether a patent demand letter requests a license fee “not based on a reasonable estimate of the value of the license” or demands payment “within an unreasonably short period of time” in deciding whether the letter was sent in “bad faith.”
We have not studied how anti-troll laws are being enforced in great detail, but our casual observation is that states have been rather cautious in enforcing anti-troll laws. As long as this continues to be the case, we think it is unlikely that the laws will prevent startups from legitimately enforcing their patents. That said, in the coming years it will be important for states and researchers to monitor how the laws are being enforced as well as any potential detrimental effects that they may be having.
Venture First: To close things off, we’d like to make note that Venture First’s headquarters is in Kentucky, one of the states yet to enact anti-troll laws. Any words of wisdom for residents in states without anti-troll laws looking to approach their legislators?
Research Team: One approach that appears to have been particularly successful is to bring to state legislators’ attention specific examples of businesses or individuals in the state that have been harmed by frivolous patent infringement claims made by Patent Trolls.[5] Of course, this does not help in states in which there may not yet be Troll activity but where the lack of an anti-troll law deters VCs from investing for fear that their portfolio companies may end up being targeted by Patent Trolls. In such instances, perhaps our study can help convince lawmakers about the benefits of protecting local businesses from frivolous patent demands.
Thanks again to Ian Appel, Joan Farre-Mensa, and Elena Simintzi for giving us some of their valuable time and thoughts. While long-term studies are still warranted, the evidence available so far is certainly promising and something to be built on.
[1] See, for instance, McDonough, J., 2006, “The myth of the patent troll: an alternative view of the function of patent dealers in an idea economy,” Emory Law Journal 56, 189-228; “Not so scary, after all: in defense of patent trolls” (Forbes, Feb. 1, 2013); or “The myth of the wicked patent troll” (The Wall Street Journal, June 30, 2014).
[2] Haltiwanger, J., R. Jarmin, and J. Miranda, 2013, “Who creates jobs? Small versus large versus young,” Review of Economics and Statistics 95, 347-361. Gornall, W., and I. Strebulaev, 2015, “The economic impact of venture capital: Evidence from public companies,” working paper, Stanford University.
[3] The full text of Vermont’s Act 44 is available at http://www.leg.state.vt.us/docs/2014/Acts/Act044.PDF.
[4] These include the Targeting Rogue and Opaque Letters (TROL) Act (H.R. 2045), the Patent Transparency and Improvements Act (S. 1720), the Saving High-tech Innovators from Egregious Legal Disputes (SHIELD) Act (H.R. 845), the Innovation Act (H.R. 3309), the Stopping the Offensive Use of Patents (STOP) Act (H.R. 2766), the Transparency in Assertion of Patents Act (S. 2049), and the Demand Letter Transparency Act (H.R. 1896).
[5] For instance, in “How Vermont could save the nation from patent trolls,” The Washington Post (Aug. 1, 2013) recounts the case of the Vermont technology company that was instrumental in convincing Vermont’s elected officials to adopt the first state anti-troll law after the firm’s clients were harassed by Patent Trolls.
