Patent trolls are amassing portfolios of patents, not to produce goods but to shake down innovative firms that use these technologies as inputs for settlement fees. The Advancing America’s Interest Act is an important step to protecting American innovators and the United States economy, writes Roslyn Layton.

America’s essential system of patent protections, a key driver of economic dynamism, is under siege. Patents provide individuals and firms with an incentive to innovate by granting them a finite monopoly over their invention. Patent litigants, however, are abusing this system by targeting innovative companies that use proprietary technologies as product inputs to extract settlement payments, grinding research and development and product sales to a halt until the case is settled or otherwise decided. 

Patent litigants, also known as “patent trolls,” operate by engaging with hedge-funded patent assertion entities (PAEs) or non-practicing entities that don’t innovate or manufacture themselves but acquire patents to build shakedown portfolios. These patent litigants use data mining to detect where these patents are deployed—frequently and unwittingly by third-party suppliers in a complex supply chain comprising the thousands of inputs that make up a typical electronic device—and then sue the final manufacturer for infringement. Patent trolls then exploit Section 337 (unfair import) investigations at the United States International Trade Commission (ITC)  to coerce target firms to pay settlement fees in the millions of dollars. The ITC was chartered in 1916 to stop the import of counterfeit goods and was never intended to become the de facto domain of patent litigation, even if global supply chains mean that many of these patented technologies are imported.

The direct costs of litigation brought by non-practicing entities (NPEs), was estimated to cost defendant firms $29 billion per year in direct out-of-pocket costs in 2012, with aggregate costs destroying some $60 billion in firm value annually. The number and share of NPE lawsuits has only grown since then. They now number 400 cases annually, quadrupling from just a decade ago. NPEs accounted for 63% of all patent litigation cases in 2022.

These massive costs are borne by American inventors and innovative companies, reducing their ability to fund research, hire employees, and build new facilities. American consumers suffer from reduced supply of innovative products and increased prices.

Fortunately, the bipartisan “Advancing America’s Interest Act” (AAIA),” updated and reintroduced in the 118th Congress, proposes to stop patent abuse by modernizing the ITC and restoring its original purpose with provisions for demonstration that the patent under litigation is used for actual products in the United States (not merely part of a patent portfolio) and public interest standards to protect health, welfare, and competitive conditions.

Patents drive American productivity but can be abused

The third edition (2022) of the U.S. Patent and Trademark Office’s (PTO) flagship report,  “Intellectual Property and the U.S. Economy,” notes the stakes in passing the AAIA. IP-intensive industries (semiconductors, pharmaceuticals, software, advanced tools and machines, etc.) accounted for 41% of U.S. output ($7.8 trillion) and 44% of jobs (62.5 million jobs) in 2019. Workers in IP-intensive industries are more likely to earn higher wages, participate in employer-sponsored health insurance and retirement plans, and be veterans. Moreover, 90% of U.S. exports involve IP. Simply put, the profits of these industries allow firms to pay workers well, invest in research, and grow.

However, exploitation of the patent system threatens these gains. University of Chicago and Federal Reserve economists Ufuk Akcigit, Sina Ates, and Craig A. Chikis show in a new paper that exploitive patent cases have tripled in the last two decades with attendant negative effects to jobs and the economy. The researchers detail how patent system distortions and associated runaway litigation harm Americans: reduced diffusion of new ideas and technology, slower economic growth, fewer startups, less jobs, and lack of innovation.

It can cost $3-5 million to defend a patent. Small firms shoulder a disproportionate burden of the costly patent abuse, impacting a quarter of their R&D spending. Many patent litigators purposely target firms with annual revenues under $100 million and time suits to coincide on “the eve of a funding or acquisition event” to capitalize further on startups’ vulnerabilities and reach an unresisted settlement. These predatory strategies chill entrepreneurship and innovation just as critical U.S. technology competition ramps up with China.

Importantly, the authors consider how NPEs could benefit the market and recognize legitimate actors like universities and hospitals. Ideally, NPEs could facilitate a better allocation of patents, for example by acting as middlemen in the secondary market and thus improving its efficiency, which in turn bolsters innovation and economic growth. Those firms that fail to commercialize their inventions may monetize them by selling them to NPEs, which can then license said patents to those needing the underlying technology for their own innovative endeavor. However, such NPE-licensed technology appears to be rare.

Unintended consequences of patent protection

In any event, the ITC functions as an alternative patent court. While the ITC awards no monetary damages, it has a more powerful weapon in the exclusion order: the ability to shut down trade of the alleged patent-infringing item while an ITC investigation is underway. Exclusion orders can block millions, if not billions, of dollars of imports. Defense in such a suit can run into the tens of millions of dollars, and literally, can put defendants out of business. Hence, most cases are settled with a payout to the patent troll.

Electronics are a key domain for NPEs, as any one smartphone contains thousands of individual patents. U.S. device makers Apple, Motorola, Google, Garmin, HP, Microsoft, InFocus, InfoSonics, and Purism are no strangers to patent infringement cases. However, the Section 337 cases also target Taiwanese and Korean manufacturers (TSMC, LG, Samsung, etc.). Ironically, when imports from these firms are blocked as part of an investigation, the unwitting beneficiaries are Chinese government-aligned device makers Xiaomi, Lenovo, Oppo, OnePlus, and so on.

Time for common sense solutions

The ITC was established to protect U.S. industries from unfair trade practices by foreign counterfeiters and infringing imported products. ITC exclusion orders should only be issued in the public interest. By modernizing the ITC and restoring its original purpose, the AAIA will protect legitimate American inventors from extortionary litigants.

The AAIA has gone through important review and revision and includes two key provisions. For one, litigants must show that the patent in question led to a product which incorporates the patent only after it was licensed to the litigant, not before. This would guard against the current practice of amassing and litigating weaponized patent portfolios by owners who have no intention to engage in product development or commercialization. Entities bringing Section 337 cases should have the burden to demonstrate a direct link between their patents and their development of actual products in America. This requirement is essential to distinguish between genuine innovators and those who exploit the system for financial gain.

A second provision of the bill would hold the ITC to higher account by requiring it to consider the public interest before issuing an exclusion order. This would make it harder for the most egregious violators to abuse the ITC in the hopes of exercising the ITC’s “nuclear option” of blocking imports that contain alleged patent-infringing elements whilst an investigation is underway. The ITC would be required to consider the potential damage to consumers, economy, and competition before issuing the exclusion order.

It is not unusual that trade and patent institutions founded in prior centuries should be periodically examined and reformed. “There is clear historical precedent for new waves of technological change and industrial organization prompting the need to revisit and adapt certain tenets of the nation’s intellectual property protection regime,” note the Fed and University of Chicago authors. Indeed, crafting policy to reduce incentive for abuse is critical.

The authors suggest solutions beyond the bill like tighter pre-grant examination and post-grant reexamination processes, as well as transparency requirements in patent litigation to disclose third-party sources of funding. Many PAEs rely on money from foreign investors or sovereign wealth funds that enable them to attack U.S. companies.

America’s property rights protections were intended to incentivize innovation and drive economic dynamism. Congress has expert evidence documenting that today’s inventors are at the mercy of greedy patent litigants. This problem has been building for two decades, and there is legislation to solve it. There is no excuse for delay.

Author’s Disclosure: Roslyn Layton, PhD is a regulatory scholar and has no financial relationships with any parties before the ITC.

Articles represent the opinions of their writers, not necessarily those of ProMarket, the University of Chicago, the Booth School of Business, or its faculty.