Troll Insurance

In fairy tales and fables, trolls are ugly little creatures that live beneath bridges. They didn’t build them and don’t own them, but they charge all who want to use them. Were such a story to be written today, the setting would be quite different, the toll more costly and there would be no assurance of a happy ending.

Patent troll is the pejorative term for those who buy patents — sometimes out of bankruptcy, sometimes directly from inventors – with the intention of pursuing patent infringement claims against well-known (read: deep-pocketed) companies. Non-practicing entities (NPEs) — the official term for these operators — have long targeted technology companies; tech firms paid out $3 billion in 2009 alone. But technology advances have become so pervasive to all forms of business that patent infringement is starting to have an impact on retailers.

“Because of the nature of the patents that are being asserted, it can take very little work on the part of an NPE to make an assertion,” says John Amster, CEO of RPX, a San Francisco-based firm that helps companies reduce NPE risks by purchasing potentially troublesome patents. “Just by going on a website, I can make a credible case that this online operation infringes that patent. It’s not like a semiconductor patent, where you have to pay someone a million dollars to reverse-engineer a product. It’s easier detection, so they’re an easy target.”

The stakes are high, and a single patent suit can ensnare dozens of retailers. One NPE, for example, sued 144 defendants over a point-of-sale patent. Another case snagged a number of online retailers, the largest of which settled for more than $40 million — a hefty return on a patent purchased out of bankruptcy for $2 million.

“If you’re an NPE, you want to go after high-transaction volume businesses,” Amster says. “When the volume of transactions is really high, the stakes could be really high. If someone was able to establish a running royalty or per-transaction charge, it could be significant.”

Business is booming
Patent infringement litigation is a growth industry, says Amster, who has spent most of his career in patents, intellectual property and mergers and acquisitions. In fact, it has become such an issue that Bloomberg Businessweek has a daily report on patents, trademarks and intellectual property issues. Law360, a newswire for the legal profession, reported that all patent suits were up 10.3 percent in the first quarter of 2010.

“For the biggest technology companies, it is 80-plus percent of all the patent litigation that they face,” Amster says. “Eight years ago, it was 15 percent. Where retailers are today is where the rest of the industries were four or five years ago.”

Some NPEs have investors to assist in purchasing patents; others may lack capital, but have the time and expertise to maximize the return. “Those are generally contingency law firms,” Amster says. “The investment theory is in acquiring an asset from an inventor or a defunct company and then taking on the risk of litigation. If you talk to patent lawyers, they’ll tell you if you sue 30 companies, you might make $100 million. The way they monetize those patents is through the threat of litigation.”

The key is volume. In infringement litigation involving retailers, “you tend to have a higher number of average defendants per case,” he says. “In some cases, you’ve had 30 to 50 defendants. In most cases, the NPE is trying to assert against a large number of companies and get a settlement not based on the asset but on the avoidance of litigation costs.”

And the issue can become more complex when a number of companies are named. “You often have the prisoner’s dilemma,” Amster says. “You don’t want to be first, but somebody inevitably talks. The next thing you know, you have 30 or 40 companies rushing to settle because nobody wants to be last.”

Companies often incur years of legal fees fighting a patent infringement suit. Take a suit in the automotive industry when 20 auto manufacturers were sued for non-catalog-based auto part sales; 19 firms settled before the trial began in 2007. Hyundai — the only manufacturer to take the case to trial — was ordered to pay $34 million and 2 percent of all revenues generated by parts sold via the web or a dealer communication system. The suit was overturned on appeal, but the plaintiff – Orion — is a familiar player in NPE suits.

According to an article in Marketwatch, Orion purchased 14 patents for $1,000 in 2004 and has filed dozens of suits across the country, targeting companies ranging from Microsoft, Nike, Google and AT&T to Costco, Staples and Lowe’s. Even without a huge payout, the legal fees can be steep. Surveys examining the financial impact of defending these suits indicated that “half of the cost goes to legal fees,” Amster says. “If an average of $1 million is at stake, you’ll pay $500,000 in legal fees. If you’re in court to the tune of $500,000 to $1 million, you might as well pay someone $300,000 to go away.”