Quantifying the 'Fight Hard' Strategy

On January 22, the Federal Circuit invalidated numerous claims from three patents asserted by Soverain Software in its five-year legal battle versus Newegg, relieving the web-based electronics dealer of what would have been a $20-25 million payout. The decision can be seen as delivering a crushing blow in this “mother of all patent battles” (Internet Retailer: "The mother of all patent battles") for the entire online retail community. Newegg and its General Counsel, Lee Cheng, deserve to be congratulated on the victory. In this instance, battling back against a notorious NPE paid off for Newegg – vindicating their position at trial, clearing an eight-figure loss, and reducing huge risk for dozens of their competitors. 

This kind of “fight hard” stance against NPEs has always held tremendous emotional resonance. Its economic foundations, however, have been more elusive, and while dodging an approximately $25 million verdict – based on the judgment of $2.5 million and a $.15/transaction running royalty – is always cause for celebration, it is worth noting that Newegg’s victory didn’t come cheap. Total costs through appeal probably exceeded $3.5 million (per AIPLA estimates) – considerably more than the amounts that other Soverain defendants appear to have paid to settle with Soverain (Internet Retailer: "The mother of all patent battles").  In fact, legal costs are so high that one could argue that unless an NPE is demanding eight figures or more, after a patent falls into the hands of an assertion entity, from a purely financial standpoint, there is no way an operating company can “win” by litigating.   

Proponents of fighting hard, including Newegg’s Cheng, would argue that operating companies who refuse to settle are actually producing two potential benefits: good case law, and a decrease in future NPE litigations (by making themselves unattractive defendants).    

Putting aside whether the underlying premise is supported by the data, (RPX: Does Fighting Hard Reduce NPE Risk?), let’s assume for a moment that fighting hard does cause NPEs to think twice and ask, how much impact would it need to have to justify the expense?

Let’s consider a hypothetical e-tailer with an average of four new NPE cases per year.  We will assume it is only possible to establish a “fight hard” reputation by refusing to settle all or nearly all NPE litigation, so the company will take almost every case all the way through trial. Each matter will take about three years and $3 million to conclude (per AIPLA estimates), so our hypothetical company would have 12 open cases each year and $12 million per year in legal costs.  Even if we presume a generous 75% success rate at trial and an average verdict of only 1x the litigation costs in losing cases each year, our hypothetical company carries roughly $15 million in NPE litigation expenses – $12 million litigating cases and a $3 million judgment for the case it loses.  

Now compare this result if the same company took a “settle sensibly” strategy that assumes an average settlement of $1 million and $100,000 in legal costs per NPE case. With the same level of litigation as above, this strategy would cost our hypothetical company only $4.4 million a year, a 71% annual reduction. Said differently, the “fight hard” strategy would have to reduce the NPE caseload by 71% for that strategy to be more attractive financially. As it happens, since Newegg took Soverain through trial in 2009 and arguably established its “fight hard” reputation, Newegg has actually seen an increase in NPE campaigns from three in 2010 to five in 2012.* While tweaking the presumptions could narrow that gap, the required reduction would still need to be massive to pay for the approach.

Of course there are clear winners in the Soverain v. Newegg case. At the time of the decision by the CAFC, there were 24 active defendants answering suits from Soverain and dozens of others retailers facing the likelihood of being named in successive waves of litigation. For these companies, Newegg’s resolve resulted in the invalidation of pivotal patent claims and saved tens of millions in potential future legal costs. Of course, none of those companies are likely to send Newegg a check for its willingness to fight the battle alone, revealing vividly one of the frustrating asymmetries of NPE litigation: that a company acting alone, either by buying a patent before it can fall into the hands of an NPE or fighting a claim through trial, bears substantial risk and costs while any success is enjoyed throughout the industry for free. Because a single NPE creates risk for an entire sector, the only rational solution is to bind together to share risk, enhance effectiveness, and make sure no one company is left holding the bag. 

Soverain Software’s 11-year litigation campaign brought in more than $60 million. The portfolio at the heart of the campaign was purchased in a bankruptcy proceeding from a failing E-commerce software start-up in 2003 (five years before RPX was founded) for a mere $590,000.  If only the 38 named defendants had joined forces to buy the portfolio in 2004, it would have required an investment of just $16,000 each. Passing the hat to the top 100 online retailers would have reduced the cost to $6,000 for each participating company. Clearly, this would have been a less expensive and more equitable way to eliminate the NPE risk from those patents than relying on a single company to “fight hard.” And because nearly three-quarters of NPEs are asserting patents that, like Soverain’s, were acquired in the open market – often from former competitors or vendors – this proactive buying strategy could prevent the majority of NPE litigations for an entire sector.  

The takeaway here is simple: operating companies like Newegg should continue to make a stand against NPEs, but making that stand unilaterally in court should not be the only – or the most common – choice. To do so is neither efficient nor fair nor economically feasible for most companies. Fighting hard must be combined with a broad-based, risk-sharing approach to provide a potent and affordable long-term solution to the NPE problem.

Total Costs ($USD M) of Fight Hard vs. Always Settle Strategies

Fight Hard Assumptions:

  • Litigation costs per case = $3 million ($1 million per year, with a duration of 3 years)
  • Losing Verdict Payment of 1x litigation costs (75% success rate, lose 1 in 4 cases)

 

Always Settle Assumptions:
 
  • Litigation costs per case = $100 thousand ($1 million per year, with duration of 0.1 years)
  • Settlement costs per case = $1 million
 

*Obviously there are many assumptions in this analysis (legal costs per case, duration, settlements/verdict amounts, success rate, etc) and the accompanying charts illustrate the sensitivity in the assumptions we’ve made.  The particulars will clearly vary by company, and if you would like to develop a similar analysis using assumptions specific to your company, please feel free to contact us.

Tags: Market-based Solution, NPE Costs, NPE Model

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