Posts Tagged 'Market-based Solution'

Newegg vs. TQP -- “Get Your Money Up Front”

January 6, 2014

As the ongoing Newegg/TQP case now moves to an appeal of the jury verdict in favor of TQP, we have mixed emotions.  On the one hand, we empathize with Newegg’s desire to fight what they view as predatory litigation.  At the same time we see this case as further proof that litigation is an astonishingly inefficient and illogical way to resolve questions of patent value.

“Illogical” because eight non-expert jurors in Texas ordered a single company  to pay $2.3 million for use of a patent that TQP has already licensed to approximately 140 other companies for, on average, about $320,000 each (more than $45 million total).  In other words, negotiation created one price; a litigation judgment created another, much higher, price.  For those who say NPE lawsuits are like the lottery, here’s proof.

“Inefficient” because to produce these nearly $50 million in payments for the TQP patent, the 140+ licensees/defendants probably spent an additional ~$25-50M in legal fees and TQP has probably spent multiple millions on plaintiff counsel.  It’s very likely that more money went to lawyers than to the patent owners – further evidence of just how irrational and wasteful the NPE business model is as a system for exchanging value.
 
The solution, as we have been saying for five years now, is to move these patent transactions out of the courtroom and into the marketplace.  Newegg’s Chief Legal Officer Lee Cheng would doubtless disagree, but the fact is that patents are assets.  They have value.  Not always high value, but a value, nonetheless.  In the Newegg/TQP case, that value was determined by a Texas jury.  In the vast majority of NPE assertions – more than 95% of cases settle – the value is determined by legal negotiation between the patent owner and “the user” usually alongside a lawsuit.  And because that negotiation is conducted by lawyers in the crucible of litigation, the cost is extraordinarily high and the price paid for the patent is often inflated.
 
We believe Cheng himself said it best in the aftermath of the verdict.  According to Ars Technica’s Joe Mullin, he congratulated the patent inventor Michael Jones and then said, “Get your money up front.”
 
Cheng was making a glancing comment on Jones’ back-end financial relationship with TQP, the NPE entity that is monetizing the patent on the inventor’s behalf.  But the remark was entirely apt and really applies to patent monetization in general.  Owners and inventors should be able to get their money early and without strings attached – before partnering with an NPE, before an assertion letter is sent, before a lawsuit is initiated, before a penny is spent on litigation-related transaction costs. 
 
Consider the TQP patent.  If Jones had been able to receive a “fair market” price without the frictional costs and years of litigation what would that price be?  In a typical monetization agreement, somewhere between 30% and 50% of the settlement amount would go to the owner of the patent, so of the $50 million in payments generated in the campaign, let’s say the owner would receive approximately $25 million (as it happens, we know from public records that the economics of Jones’ deal included an upfront payment and markedly lower back end percentage).  It’s important to remember, however, that this kind of monetization demands years of uncertainty and legally-induced stress before payout.   Most patent owners would very likely accept far less than $25 million for an early, guaranteed payment. 
 
But even if the TQP patent were worth paying as much as $20 million to the owner (which is very unlikely in our experience), the prorated cost to the 140 licensees would have been about $145,000 each.  In retrospect, that would have been a huge bargain compared to how the litigation process played out.
 
Clearly, sharing the cost and risk of patent monetization would have made sense in the TQP campaign.  The defendants would have paid less.  The owner would have been (very) fairly compensated.  The unnecessary $25+ million in legal transaction costs would have been almost entirely eliminated.  And this kind of efficient outcome was entirely possible.  All that was needed to make it work was a critical mass of participating companies and a sufficient pool of capital to acquire the TQP patent in the open market. 
 
That very system, of course, is working every day at RPX.  We have interceded in the market to clear more than 4,000 patents and avoid thousands of lawsuits over the past five years.  As our membership and capital resources continue to grow, the companies in the network can further reduce their litigation risk, while inventors can receive fair market value without the incremental costs of a contingency arrangement.  Hopefully the next patent owner with a valuable asset to sell will take the more economically efficient – and financially lucrative – path and get his money “up front”.  If so, we look forward to his call.

Tags: Market-based Solution, NPE Costs, NPE Inefficiency, Patent Litigation

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Quantifying the 'Fight Hard' Strategy

February 21, 2013

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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Does Fighting Hard Reduce NPE Risk?

September 4, 2012

When it comes to NPE litigation, agreeing to settle can be hard to accept.  Fighting back and fighting hard seems attractive – it just feels right.  But is it the cost-effective way to deal with a patent assertion?  Based on data RPX has been compiling from its clients and public sources the answer seems to be “generally no”.

Consider the two typical arguments in favor of the “fight hard” position:

  1. Fighting hard earns a company a reputation as a tough target.  You will be sued less often.
  2. Fighting hard saves money.  It will reduce settlements by more than the additional legal cost.

 

As for the first argument, neither our data nor our experience support it.  In our frequent negotiations with NPEs to buy assets and/or release RPX clients from litigations, we have never heard that a company’s reputation for fighting or not fighting has ever influenced the NPE’s decision to name a defendant.

Furthermore, we analyze several thousand NPE suits each year, and have never seen compelling evidence that companies that persist in litigation longer are sued less often.  In fact, companies that stay in NPE cases longer – a proxy for a “fighting hard” reputation – appear to have the same (or worse) growth in NPE suits compared to companies that resolve cases faster.  For example, plaintiffs that averaged more than 370 days in suit saw their NPE caseloads grow at approximately 36% from 2008 to 2011, no different than companies that were resolving NPE cases in less than 370 days.

The second argument also seems to be a fallacy.  In our experience, NPEs consistently report that the range at which they would be willing to settle is generally lowest near the start of the case.  This makes basic mathematical sense: an NPE seeking a 20% annual return to investors would be willing to accept approximately 30% less for settling now versus two years hence.  Moreover, when factoring in costs of plaintiff counsel of 10-25% of the expected settlement, an NPE would probably accept even less now versus two years in the future. 

That is consistent with our data.  In more than 500 litigations we examined, cases that last longer than one year had all-in costs that were fully five times higher than in cases lasting less than a year. 

Skeptics could look at this data and claim that it actually proves a solid legal defense is the only way to achieve a favorable settlement – that defendants need to fight hard for at least a year to establish a strong negotiating position.  Some observers might assert that the longer-lasting cases probably had higher initial demands and fighting hard paid for itself by actually reducing the ultimate settlement.

Which raises the question: where should the burden of proof lie in the “fight hard” question?  Those with the most to gain from pursuing an aggressive defense strategy should be able to provide evidence that fighting hard pays dividends, either in the form of fewer litigations or lower payouts.  Fighting an unreasonable demand is always warranted, but our data indicates that there is little to be gained from being impractically intransigent.

The simplest and most logical approach is to treat a patent assertion as what it is: a business transaction.  Before calling legal counsel, open a dialogue with the NPE to find out what the financial demands are.  Conduct a cost/benefit analysis of fighting versus settling.  Again, if the demands are unreasonable, defendants can and should be ready to fight.  But in the great majority of cases, making a reasonable counter-offer is likely to produce a settlement that is a more cost-effective result than a “fight hard" stance.  Building a reputation for being tough on NPEs is expensive and the reputational benefits are elusive, at best.

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

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