Inflated Damages and Secret Funding Distort Patent Litigation

When most of us hear someone hit the jackpot, we think about slot machines in Las Vegas or lottery tickets from a local convenience store. When hedge funds and other investment entities hear that, many now think about investing in lawsuits.

Litigation funding has become a multi-billion dollar industry, operating with little to no oversight. Areas like patent infringement litigation are seeing a flood of new money, tempting investors with massive damage awards.

In an investor rush to turn big profits by exploiting intellectual property, we shouldn’t lose sight of the harm they are inflicting on US inventor-manufacturers along the way.

Damaging Process

The combination of inflated patent litigation damages and little funding transparency fuels abusive litigation, ultimately discouraging new technological advances and driving up costs across the board.

Rebalancing damages calculations and mandating funding disclosures would allow for the fair resolution of patent lawsuits, while also incentivizing innovation.

In 2021, the US commercial litigation finance industry, where investors back lawsuits in exchange for a large share of any settlement or award, had over $12 billion in assets under management.

This increase of over $1 billion from 2020 includes a 61% year-over-year increase in the percentage of new capital commitments dedicated to patent litigation.

Patent litigation has been called a natural fit for financing because of its “high reward nature” and recent damage awards in the hundreds of millions and billions of dollars.

NPEs

Litigation funders often invest in patent litigation through shell companies called non-practicing entities, whose only purpose is to serve as vehicles for lawsuits. NPEs create no products and have low operating costs, which removes many risks associated with repeatedly initiating frivolous litigation.

In most courts, NPEs are not required to disclose their funding sources, so investors remain hidden.

Facing relatively small downside, NPEs see a massive upside in patent infringement litigation because of how damages are calculated. Typically, damage awards are determined by lost profits or reasonable royalties for infringement. NPEs have no products, and therefore no lost profits, leaving cases to be determined by reasonable royalties.

But so-called “reasonable” royalty damages have been inflated through a self-reinforcing cycle, as detailed by Stanford professor Douglas Melamed and intellectual property attorney William Lee.

First, patent infringement damages can take into account developments from after the alleged infringement occurred, including things like research and development and market testing. So, the more successful an accused infringer has been, the greater damages NPEs can claim.

Second, licensing negotiations often happen around the same time as infringement proceedings, and higher potential damage awards allow NPEs to demand more in licensing agreements.

Finally, fees negotiated as part of licensing agreements are another key factor in calculating damages, restarting the cycle and pushing damages even higher.

‘Reinforcing Cycle’

As summarized by Melamed and Lee, problems in the current system result in a “reinforcing cycle that perpetuates inflated patent damages and imposes a wasteful drag on commercial development and innovation, and an inefficient tax (in the form of higher prices) on the public.”

More complex legal arguments aside, damages trends also don’t pass a smell test. Over the past two years, damages sought by the NPE VLSI Technology LLC against the American semiconductor manufacturer Intel has resulted in some eye-popping award numbers.

Most recently, in November, VLSI was awarded nearly $1 billion in damages related to one of 18 patents it purchased from NXP Semiconductors for $3 million in 2018.

In 2018, VLSI—a shell company owned by Fortress Investment Group—purchased a patent that had “sat on a shelf” since it was issued in 2009, along with 17 others, for $3 million. VLSI then immediately turned around and said it was worth nearly $1 billion in an infringement claim.

This dynamic is common in NPE cases. Are we really supposed to believe that companies like NXP are regularly and drastically underestimating the value of their property, or is something deeply flawed with how infringement damages are being calculated?

NPEs and the funders that support them have been shown to impose significant costs on innovators. A combination of limited litigation risk, ensured by shell company arrangements and funding anonymity, and high litigation upside, provided by inflated damage claims, create an unhealthy environment for American inventor-manufacturers.

When I helped lead Congress’s effort to pass the America Invents Act in 2011, damages reform was hotly debated, but eventually left aside for the greater benefit of enacting the law.

It is now past time for Congress to return its attention to damages reform and litigation funding transparency, to rebalance patent litigation incentives and reduce abusive lawsuits that drag down America’s innovation economy.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

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Bob Goodlatte represented Virginia’s 6th District in Congress from 1993 to 2019 and chaired the U.S. House of Representatives Judiciary Committee from 2013-2019.