The Texas town of Marshall has a population of 25,000 people, 2,000 of whom are students attending one of the four colleges that have earned Marshall the nickname "Athens of Texas." Marshall is also home to a historic pottery industry and one of the country's largest holiday light shows, the "Wonderland of Lights."
Marshall's most booming industry these days, however, is based in the Baxter Building, an unassuming three-story brick office space in the center of town. Twenty-five businesses fill the space, but don't look for employees—many of the offices are empty.
“It looks overwhelmingly like NPEs are just targeting firms that are more likely to pay out”
Known as Non-Practicing Entities (NPEs), the companies in the Baxter Building are located in Marshall for one reason: the federal courthouse next door. There, they bring tons of lawsuits accusing other companies of infringing on technology patents—and win many of them
In the past few years, NPEs have sued Apple, Samsung, eHarmony, Martha Stewart Living, and hundreds of other companies, sometimes winning judgments for hundreds of thousands of dollars.
Proponents say that non-practicing entities play a valuable role by sticking up for small inventors, going up against big companies that steal the ideas of entrepreneurs who are unable to fight their own legal battles. (NPEs acquire patents either by purchasing them from companies, inventors, and academic institutions, or by being assigned them in the first place for original work.) If it weren't for NPEs, the argument goes, resource-rich companies would be free to steal ideas of small inventors without fearing retaliatory lawsuits—and this would poison the business environment.
But critics have another name for many NPEs: patent trolls. In this view, a significant number of non-practicing entities acquire patents for the sole purpose of coercing companies, mostly technology firms, into paying licensing or settlement fees (whether justified or not).
Are NPEs friend or foe?
New research coauthored by Lauren H. Cohen, professor of finance at Harvard Business School; Umit G. Gurun, of University of Texas at Dallas; and Scott Duke Kominers, of the Harvard Society of Fellows, attempts to answer that question by studying which firms NPEs target in litigation, when the litigation occurs, and the impact of the legal challenges on the targeted firms' abilities to innovate and grow. Their paper, released in July, is entitled "Patent Trolls: Evidence from Targeted Firms."
The research concludes that NPEs not only go after the most susceptible, cash-rich targets, but in the process damage those companies' abilities to innovate in the future.
A Lucrative Business
Patent trolling can be a lucrative undertaking because of the ambiguous nature of intellectual property. "A patent troll is a firm that sues opportunistically in hopes that an imperfect legal system will rule in its favor, maximizing expected proceeds rather than penalties to infringement," says Cohen. Patent trolls bank that, in some cases, companies will settle rather than pay the time and monetary costs of fighting infringement lawsuits. In others cases, patent trolls seek sympathetic judges who will rule in their favor. "Patent trolls are exploiting inefficiencies in the legal system regarding how we define and enforce intellectual property rights."
Add to those inefficiencies the fact that patents are not like other kinds of property, where ownership is clear-cut. "Unlike tangible property like a farm, where I can say, 'I legally own this land, and you are planting on it,' the intellectual property space is relatively amorphous. It can be hard to tell whether you are infringing on my intellectual property or not."
Congress has found it hard to act on the patent troll issue. To date, twelve pieces of legislation have been proposed to clamp down on NPEs but none have passed—in part because no one knows how many NPE lawsuits are genuine and how many represent trolling.
To understand the behavior and impact of non-practicing entities, Cohen, Gurun, and Kominers used a database of 720 NPEs and 2,100 of their subsidiaries. The researchers found some 11,000 court cases in which NPEs sued for patent infringement. In 3,500 of those cases, the defendants were publicly traded—so the researchers were able to determine whether the lawsuits looked legitimate or more like mere money grabs.
The evidence points definitively troll-ward. "The biggest predictor of whether you will be sued is whether you have a lot of cash or just came into an increase of cash," says Cohen. "It looks overwhelmingly like NPEs are just targeting firms that are more likely to pay out."
In fact, the researchers found that for every $2 billion or so in cash holdings, a company was six times more likely to be sued by an NPE. Furthermore, they found that NPEs tend to go after firms that have small legal teams, or those engaged in other (non-IP-related) litigation—perhaps hoping for easy settlements. "If [NPEs] really thought they had a great case as stewards of intellectual property, it wouldn't matter how many lawyers a target company had," argues Cohen.
The most incriminating piece of information in the data concerns conglomerates—companies that make profits from several different, unrelated forms of business. In those cases, the researchers found, NPEs were just as likely to sue regardless of whether the firm's profits were derived from the part of the business related to the alleged patent infringement or not.
Cohen illustrates the point: "Take a company with a lumber division and an information technology division, in which all the profits come from the lumber business but all the patent holdings are on the IT side. If an NPE has a legitimate concern that this company is infringing on the NPE's technology patents, then it wouldn't sue, as the company is not profiting from those patents. Trolls, however, will go after the lumber profits by suing for infringement on the tech patents, even though they are unrelated to the lumber business."
"NPEs are suing for infringement on patents that are worthless—and that is damning," Cohen says.
“NPEs are suing for infringement on patents that are worthless—and that is damning”
Not only do the researchers' findings support the conclusion that NPEs on average act as patent trolls, but one analysis of the data shows that NPEs are actually damaging the firms that they sue. Cohen and his colleagues found that after an NPE lawsuit, a company on average produced fewer future patents and invested less in research and development than comparable companies, hurting chances for future success.
If the majority of NPEs are, in fact, patent trolls, then there is new urgency for legislation that makes it harder for them to sue, perhaps by increasing the cost of bringing cases, or by putting more of the burden of proving actual infringement on plaintiffs. Already, the research has garnered attention from Congress: it was recently cited by Senator Orrin Hatch on the floor of the Senate. Cohen hopes that the team's research can inform the debate over legislation limiting NPEs' abilities to bring frivolous lawsuits.
"One of the reasons that anti-trolling laws haven't passed already is because the data hasn't been there—and you don't want to legislate based on anecdotes," Cohen says, "I think our work really fills that gap."