Tech patent arbitrage spawns trolls and exchanges

July 15, 2010

EBay is being sued for $3.8 billion by an outfit called XPRT Ventures. It’s not alone. Many big technology companies are regularly hit by patent infringement lawsuits. It’s lucrative for the plaintiffs — but terribly inefficient. There are better ways to balance invention and reward.

Here’s the basic pattern. An investment firm buys a pre-existing patent for, say, $2 million. It then sues perhaps a dozen companies that use technology similar to, or overlapping, the patent. Each firm that fights may end up paying $500,000 or much more to defend itself and could also face large penalties if found to have infringed. The alternative is to settle for, say, $1 million or so. If just three firms pay up to avoid a battle, the patent owner makes big money.

The number of patent lawsuits of this kind is rising. Last year there were nearly 500 cases, more than six times as many as in 2001. Speculative “patent trolls” have been able to accumulate intellectual property rights partly because inventors and small companies often find it simpler to sell their patents than administer them.

Sometimes the claims of infringement are legitimate, often because there’s a coordination issue. Take the example above. None of the dozen firms wants to spend $2 million up front to buy a patent it may not be infringing — especially when the worst possible outcome is forking over $1 million in a settlement.

The arbitrage has attracted big bucks. Intellectual Ventures, set up by two Microsoft alumni, has raised $5 billion from investors and has acquired tens of thousands of patents. The firm prefers to establish licensing agreements rather than litigating. Yet it still has an incentive to extract as much revenue as possible.

The exchange model of start-up RPX looks like one better way to deal with the issue. The company charges tech firms a fixed amount, about $5 million annually for the biggest customers, and buys up patents. It also promises not to raise fees over time. Since big companies typically face a dozen infringement claims annually, according to the American Intellectual Property Law Association, that seems like cheap insurance — especially once RPX gathers a critical mass of patents. Microsoft, Verizon and Intel are among those involved. RPX pockets a chunk, or course. But for the tech groups, that is less of a lottery than paying the trolls.

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