Patent privateering, litigation, and R&D incentives

• Author: Jorge Lemus,Emil Temnyalov
• DOI: http://doi.org/10.1111/1756-2171.12211
• Date: 01 December 2017
• Published date: 01 December 2017

RAND Journal of Economics

Vol.48, No. 4, Winter 2017

pp. 1004–1026

Patent privateering, litigation,

and R&D incentives

Jorge Lemus∗

and

Emil Temnyalov∗∗

Wemodel “patent privateering”—whereby producing firms sell patents to Patent Assertion Enti-

ties (PAEs), which then license them under the threat of litigation—in a bargaining game. PAEs

can negotiate higher licensing fees than producing firms because they cannot be countersuedfor

infringement. Privateering produces two countervailing effects:it increases the offensive value of

patents, whereas it decreasestheir defensive value and lowers the aggregate surplus of producing

firms. Embedding the bargaining game into a Research and Development (R&D) contest for

multiple complementary technologies, we find that privateering may increase R&D investments,

even as it induces more litigation threats and reduces industry profits.

1. Introduction

Patent Assertion Entities (PAEs)are companies that typically neither invest in R&D nor use

their acquired patents to make new products. Over the past decade, they haverisen to prominence

by filing complaints for patent infringement and demanding payments for patent licenses under

the threat of engaging in costly litigation.1Whereas most of the discussion on PAEs has focused on

the ability of nonproducing entities to extract licensing payments from producing firms, our article

∗University of Illinois at Urbana-Champaign; jalemus@illinois.edu.

∗∗University of Technology Sydney; emil.temnyalov@uts.edu.au.

We thank twoanonymous referees and the Editor, Kathryn Spier, for their excellent comments and suggestions. We are

grateful to Michael Whinston and William Rogerson for their guidance and support. Wealso thank Kevin Bryan, Gonzalo

Cisternas, Jeffrey Ely, Erik Hovenkamp, Benjamin Jones, Elliot Lipnowski, Aviv Nevo, Robert Porter, and discussants

and attendees at the Law and Economics Theory Conference (2015), ATE Symposium (2015), IIOC (2015), Searle

Conference on Antitrust Economics and Competition Policy (2015), TOI8 (2015), the Munich Conference on Innovation

and Competition (MCIC 2014), EconCon (Princeton University, 2014), and seminar audiences at MIT, Northwestern,

Notre Dame, UIUC, UNSW,and UTS. This article was previously entitled “Outsourcing patent enforcement: the effect

of ‘patent privateers’ on litigation and R&D investments.” Temnyalov acknowledges financial support from the UTS

Business Research Grant 2017.

1The US FederalTrade Commission recently published “Patent Assertion Entity Activity: An FTC Study” (October

2016). Severalbills have been passed or proposed in Congress, including the SHIELD Act, the Patent Quality Improvement

Act, the America Invents Act, and the End AnonymousPatents Act. President Barack Obama also publicly addressed the

issue of PAEsin “Patent Assertion and U.S. Innovation” (June 2013).

1004 C2017, The RAND Corporation.

LEMUS AND TEMNYALOV / 1005

explores the economic incentives behind the less-understood practice of “patent privateering,”

whereby a producing firm sells patents to a PAE, which then licenses them under the threat of

litigation to other producing firms, typically rivals of the original patent owner. We present a

theory to study how PAE privateers affect R&D investmentsand the licensing of patent portfolios

under the threat of costly litigation.

Patent privateering has recentlygained attention in both academic and policy debates. Ewing

(2012) provides a detailed description of this phenomenon. In 2013, several large technology

firms sent the Federal Trade Commission and the Department of Justice a letter asking for

more scrutiny on privateers. An extract from this letter illustrates the concern for this patent

monetization strategy2:

PAEs impose tremendous costs on innovative industries. These costs are exacerbated by

the evolving practice of operating companies employing PAE privateers as competitive

weapons. The consequences of this marriage on innovation are alarming. Operating com-

pany transfers to PAEs create incentives that undermine patent peace. [ ...]Wetherefore

urge the antitrust agencies to study carefully the issue of operating companypatent transfers

to PAEs.

To the best of our knowledge, no scholar has empirically assessed the extent of patent

privateering, although anecdotal evidence suggests this practice is pervasive. Examples of firms

that have engaged in privateering include Alcatel-Lucent, British Telecom, Digimarc, Ericsson,

Kodak, Micron Technology, Microsoft, Motorola, Nike, Nokia, Philips, Sony, Xerox, and many

others. Nokia and Sony,for instance, sold some of their patent por tfolios to MobileMedia, a PAE

which subsequently sued Apple, HTC, and Research In Motion.3Micron Technology, one of the

largest memory chip makers in the world,sold at least 20% of its patent por tfolio to Round Rock,

in multiple transactions between 2009 and 2013. Round Rock, a PAE, asserted these patents

against SanDisk, a rival of Micron.4

Our setting incorporates key features of the patent landscape: costly litigation is often

resolved through pretrial settlement; a firm’s patent portfolio may protect some, but not all, of

the components embedded in a product; a firm accused of patent infringement by a producing

firm may countersue for patent infringement as a defensive strategy; PAEs cannot be countersued

for infringement because they do not sell products; patents are “probabilistic property rights,”

as their scope and validity are uncertain. Some of these features are especially relevant to high-

tech industries, where final products are made up of multiple patented technologies. Holding

large patent portfolios is becoming the rule rather than the exception in many industries—some

examples include smartphones, wearable devices, and even financial transactions technology for

banks.5When a firm is sued for patent infringement, there are generally two different kinds

of defenses: challenging patent validity and countersuing for infringement. Both producing and

nonproducing firms are exposed to validity challenges. However, onlyproducing fir ms are exposed

to patent infringement countersuits. Although countersuing for patent infringement plays a crucial

role in the litigation strategy of producing firms (and is one of the reasons why they amass large

portfolios in the first place), patents cannot be used defensively against PAE privateers, because

they do not produce.

2patentlyo.com/media/docs/2013/06/pae-0047.pdf (accessed October 2016).

3“Patent Privateers Sail the Legal Waters Against Apple, Google,” by Decker (Bloomberg, Jan. 10, 2013).

4“Patent ‘Troll’ Tactics Spread,” by Ashby Jones (WSJ July 8, 2012). See also www.law360.com/

articles/520387/sandisk-accuses-round-rock-of-patent-antitrust-plot. In the web Appendix A, we further elaborate on

several high-value cases and discuss howpatent privateering could be studied empirically.

5For example, Lloyd, Spielthenner, and Mokdsi (2011) discuss smartphone portfolios. See www.chipworks.

com/about-chipworks/overview/blog/assessing-the-patents-the-jawbone-vs-fitbit-lawsuit for a description of patent port-

folios protecting wristbands (accessed October 2016). See www.law.edu/res/docs/2015-0702-AmericanBankerArticle.pdf

for a description of patent portfolios of banks (accessed October 2016).

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The RAND Corporation 2017.