The Vonage trilogy: a case study in "patent bullying".

• Author: Sichelman, Ted

ABSTRACT

This Article presents an in-depth case study of a series of infringement suits filed by "patent bullies. " Unlike the oft-discussed "patent trolls"--which typically sell no products or services and perform no R&D--patent bullies are large, established operating companies that threaten or institute costly patent infringement actions of dubious merit against smaller companies, usually in order to suppress competition or gamer licensing fees. In an ideal world of high-quality patents and optimal patent licensing and litigation, infringement suits by aggressive incumbents would have a cleansing, almost Darwinian effect. Yet, defects and distortions in patent examination, licensing, and litigation--the very problems that are raised constantly in the context of patent trolls--generally apply with equal and, often, greater force to patent bullies. Nonetheless, patent bullies have scarcely been discussed in the academic literature or popular press, especially in recent years.

This Article examines three patent infringement suits filed by incumbent telecommunications carriers--Sprint, Verizon, and AT&T--against Vonage, then an early-stage company providing consumer telephone services over the Internet. Based on a detailed analysis of the patents-at-issue, prior art, court documents, and news accounts, it shows that the incumbents were able to exploit defects in the patent system in order to prevent disruptive technologies from competing with their outmoded products and services. Because startups like Vonage typically lack the resources to vigorously defend against even weak patent suits, patent bullying can result in severe anticompetitive effects. The incumbents in the Vonage suits achieved their intended result--drastically reducing Vonage's stock price, severely weakening its position in the market, and placing it at the brink of insolvency. This case study demonstrates that further theoretical and empirical study is warranted to assess the full extent of the patent bullying problem.

INTRODUCTION: THE OVERLOOKED PROBLEM OF PATENT BULLYING

In the last ten years or so, academics, the media, the Federal Trade Commission, and the Supreme Court have been fixated on so-called "patent trolls"--loosely, entities and individuals that generate the bulk of their revenue from patent litigation and licensing, but do not make and sell products that embody their patents and that, typically, perform little to no research and development relating to their patents. (1) Yet, the exact problem trolls present to the patent system has remained somewhat elusive. (2)

Many focus their attention on the non-practicing nature of trolls, exhorting that patentholders that do not sell commercial products embodying their patents are behaving contrary to the goals of the patent system. (3)

However, this view is clearly wrong, at least as a descriptive matter, because the Supreme Court has firmly held that "it is the privilege of any owner of property [including patents] to use or not use it, without question of motive." (4) Indeed, the most widely accepted explanation of the patent system--the "reward theory"--posits that patents are designed to spur invention and its disclosure in patents to the public, but generally are unnecessary to promote the commercialization of inventions. (5) Instead, reward theorists believe that once inventions are created and disclosed, the market will efficiently yield commercial embodiments of those inventions. (6) Although there is a strong normative argument that the patent system should actively promote commercialization--and I am squarely in favor of this view--American patent law has long shied away from this approach. (7) Thus, under current law, trolls not commercializing their inventions can scarcely justify the views of those aligned against them. (8)

Another oft-touted criticism of trolls is that they perform little to no research and development (R&D) on their patents. (9) Yet, this view seems as odd as the commercialization concern. Patents have always been tradable, either through outright sale or licensing, (10) and nobody would argue that only the original inventor should be able to sue for infringement. (11) Although trolls themselves might not perform R&D, the inventors listed on the patents presumably did, so saying that trolls thwart the patent system because they undertake no R&D is not much different from saying GE thwarts the patent system, because only its engineers--who assign their patents to their employer, GE--perform research. (12) Rather, from the perspective of contemporary economics, there is little difference between a vertically integrated entity like GE and an effective joint venture between independent inventors and a troll assignee--indeed, the joint ventures are often more efficient means of producing inventions. (13)

In sum, the two key features of trolls as they are commonly defined-- namely, that they do not commercialize their patents and perform little to no R&D--are red herrings when it comes to the problems they create for the patent system, at least on the widely accepted, reward theory of patent law. (14) Rather, the major concern over trolls seems to stem from their single-minded goal of earning revenue from patent litigation and licensing. (15) This quest for patent-induced profits appears to channel many trolls into aggressively exploiting defects in patent examination, licensing, and litigation in ways that other patentholders often do not. (16) Indeed, on this view, the term "troll" should be limited only to--and is well deserved for--those non-practicing entities that abuse the patent system. (17) However, to be certain, any patentholder can--and many do--take advantage of these systemic defects, (18)

There are at least four serious defects in the patent system. First, although the empirical research is limited, it appears the Patent Office issues many patent claims that are arguably anticipated or obvious in view of prior technology; overly broad given the scope of the patent disclosure; vague, ambiguous, and generally difficult to interpret; and introduced and amended long after the original patent disclosure is filed. (19) Despite the seemingly endless number of "bad" patents, there is a "[p]resumption of validity" that patents are properly granted, (20) which makes invalidating them in litigation quite costly--usually a million dollars or more. (21) Second, patentees and potential infringers face unusually high transaction costs in licensing negotiations and litigation, which is fueled in large part by uncertainty and instability in many patent law doctrines. (22) The distorting effects of these costs are especially problematic in technological fields for which patent search and analysis are difficult. (23) Third, patentholders can delay assertions of infringement until a relevant market is well developed and the costs of switching to a non-infringing technology are exorbitant. (24) Fourth, asymmetric resources, stakes, and levels of risk-aversion between repeat players, such as trolls and large patentholders versus one-time players, such as startup companies, can result in highly skewed litigation outcomes, especially when substantial damages are at stake. (25)

Although trolls appear to be especially adept at exploiting these defects, they are not the only group doing so. Another important class of patentholders--namely, large practicing entities that often hold many patents--appear to be exploiting the same sorts of defects, and potentially, at much greater rates. (26) Just like the trolls, these "patent bullies" take full advantage of weak, uncertain, and vague patents; the high costs of litigation; the ability to delay lawsuits; and their massive resources in order to engage in highly anticompetitive behavior, often against market entrants and startups. (27) Specifically, patent bullies assert their patents against entrants to prevent innovative, disruptive technologies from competing with the bullies' outmoded products. (28) Additionally, bullies desiring to enter a new market wield their patents against startups that are already well positioned in the market. (29) In particular, a patent bully can file an infringement suit to compel a license from a startup to its innovative technology--which, in turn, the bully uses to trounce the startup by leveraging pre-established production capacity, marketing channels, and general goodwill, as well as by engaging in effective predatory pricing by tying the innovative product to the sale of preexisting products. (30) These effects are often compounded by keiretsu-style, cross-licensing agreements among industry incumbents, which provide a veritable zone of freedom to the incumbents, but a wall of impenetrability to entrants. (31)

The remainder of this Article provides an in-depth description and analysis of the patent bullying problem by undertaking a case study of a trilogy of suits filed by incumbent telecommunications carriers against Vonage Holdings Company (Vonage), an early-stage company that provides consumer telephone services over the Internet. (32) By evaluating the decisions of Vonage's and Sprint's counsel in the context of the patents-in-suit, accused technology, prior art, and hired experts, this Article offers an atypical, "law in action" approach (33) for assessing the defects of the present patent system. (34) Such a mode of inquiry is radically different from not only the doctrinally oriented analyses that generally ignore the effects of counsel on case outcomes and judicial opinions, but also the high-level empirical analyses that tend to abstract away from the day-to-day decisions of parties, lawyers, and judges. (35)

More concretely, this Article examines how Sprint, Verizon, and AT&T filed suits to prevent Vonage from continuing to gain market share from the carriers with its disruptive, Internet-based, consumer telephony services. (36) Although it appears that all or...