Patent trolls obliterate innovation

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.