Expanding the Customer Suit Exception in Patent Law

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1 Expanding the Customer Suit Exception in Patent Law 1 J A M E S C. YOON W I L S O N S O N S I N I G O O D R I C H & R O S A T I 1 2 T H A N N U A L I N T E L L E C T U A L P R O P E R T Y S C H O L A R C O N F E R E N C E S T A N F O R D L A W S C H O O L

2 First to File Rule 2 First to File allows a federal district court to transfer, stay, or dismiss an action when a similar complaint has already been filed in another federal court. Alltrade, Inc. v. Uniweld Products, Inc., 946 F. 2d 622, 623 (9 th Cir. 1991). While the first-filed rule may ordinarily be a prudent one, it is only because it is sometimes more important that there be a rule than that the rule be particularly sound. Codex Corp. v. Milgo Electronic Corp., 553 F.2d 735, 737 (1 st Cir. 1977)

3 Customer Suit Exception 3 A later filed patent case against (or by) the manufacturer of an allegedly infringing product takes precedence over an earlier filed suit against customers of the manufacturer. Pragmatus Telecom, LLC v. Advanced Store Company, CA No RGA (July 10, 2012) Courts stay the earlier filed patent case against the customer so that the later-filed case involving the manufacturer proceeds in a different forum than the customer case. Katz v. Lear Siegler, 909 F.2d 1459, 1464 (Fed. Cir. 1990)

4 Customer Suit Exception - Rationale 4 Manufacturer is the true defendant in a customer suit since it must protect customers, either as a matter of contract, or good business, in order to avoid the damaging impact of an adverse ruling against its products. Manufacturer has a greater interest in defending patent claims than an individual customer, who may be more concerned with reducing the litigation costs than litigating the merits of the patent case. Katz v. Lear Siegler, 909 F.2d 1459, 1464 (Fed. Cir. 1990) Kahn v. General Motors Corp., 889 F.2d 1078, 1081 (Fed. Cir. 1989) Delamere Company v. Taylor-Bell Co., Inc., 199 F.Supp. 55, 57 (S.D.N.Y. 1961)

5 True Defendant: Legal 5 Manufacturer case is more likely than the customer case to resolve dispute between patent holder and the accused technology. Finding of invalid or unenforceability will end current (and future) customer case. Finding of non-infringement will likely resolve current (and future) customer case with respect to manufacturer product. In the cases involving NPEs, finding of validity and infringement will likely resolve customer suit because patent holder will be precluded from seeking further damages.

6 True Defendant: Reality 6 Manufacturers make long term investments in the accused technology. Manufacturers focus on current and future products that incorporate the accused technology. Manufacturer possesses incentives and greater capability to (1) vigorously litigate the case on the merits and/or (2) negotiate settlement consistent with the actual value of the patented technology and the financial realities of businesses in the field of the invention.

7 True Defendant: Reality 7 Because of its investments and history in the field of the patent, manufacturers possess (1) deep technical expertise with regard to the accused products and the field of the patent and (2) strong understanding of the economics associated with their products. Early in cases (without expert assistance), manufacturers can develop defenses to patent case and perform a risk assessment with respect to litigation.

8 True Defendant: Merits 8 1. Non-Infringement: Manufacturer possesses detailed knowledge of accused product. Best position to generate non-infringement arguments and create design around options to the asserted patent. 2. Invalidity: Manufacturer often has engineers who have worked in the field of invention for substantial period of time. Manufacturer in best position to identify prior art to invalidate patent and assist counsel in developing invalidity defenses.

9 True Defendant: Merits 9 3. Damages: Manufacturer understands the economics of the accused technology and is in best position to assess the alleged value of the patented feature. a. Manufacturer in a better position to attack patent holder attempt to apply entire market rule to the calculation of a reasonable royalty. b. Manufacturer in a better position to apportion value of nonpatented and patented features.

10 Customers: The Reality 10 Compared to manufacturers, customers begin patent cases in a substantially worse position. Customers often lack detailed understanding of the design of the accused products. Information in possession of manufacturer. Customers frequently lack technical knowledge in field of patent and, as a result, are not in a good position to identify prior art and develop invalidity arguments.

11 Customers: Outside Experts 11 Because they lack the technical expertise in the accused products and deep knowledge in the field of the patent, customers are forced to rely on outside experts. Experts are expensive. Create pressure to settle or pay royalties on weak patents. Experts do not have access to the detailed design information on the accused technology. As a result, experts fail to provide accurate assessments early in litigation. Experts may be selected for testifying experience, not actual industry expertise.

12 Courts Unduly Restrict Exception 12 Courts restrict the customer suit exception to situations that advance judicial economy. Courts focus on how application of the exception will impact the docket. Courts tend to limit the customer suit exception to situations where two conditions are met: (1) manufacture is responsible for all (or almost all) the accused products in a case (which may involve multiple defendants) and (2) the manufacturer suit would substantially resolve the first filed litigation.

13 Inherent Power of the Courts 13 The power to stay proceedings is incidental to the power inherent in every court to control the disposition of cases on its docket with economy of time and effort for itself, for counsel, and for litigants. Courts have the discretion to stay cases when the interest of justice requires. See Cheyney State Coll. Faculty v. Hufstedler, 703 F.2d 732, 737 (3d Cir. 1983); Pragmatus Telecom, LLC v. Advanced Store Company, Inc., et. al., Dist. Court, D. Delaware 2012.

14 Inherent Power of the Courts 14 Three Factor Test for Stay 1. Whether granting stay will simplify issues; 2. Whether discovery is complete and a trial date is set; and 3. Whether stay will cause the non-moving party to suffer undue prejudice from any delay or a clear tactical disadvantage. See Pragmatus Telecom, LLC v. Advanced Store Company, Inc., et. al., Dist. Court, D. Delaware 2012.

15 Non-Practicing Entities ( NPE ) 15 NPEs exploit the inefficiencies and costs of the patent system to generate revenue from defendants. Current system rewards NPEs for not manufacturing or selling products. NPEs are immune to patent counterclaims. Other than legal expenses, downside risk of patent litigation are disproportionately borne by defendants. NPEs minimize legal expenses through contingency fee plaintiffs bar. NPEs obtain a premium on weak patents.

16 Non-Practicing Entities ( NPE ) 16 NPEs choose customer defendants over manufacturers because a customer defendant is typically a one-time player with no incentive to help its manufacturer or stop the NPE. NPEs recognize that independent of the merits of the case most customers will take the option that costs them the least. Generally, a settlement is priced less than expected cost of litigation.

17 Number of NPE Cases Increasing 17 NPE cases are increasing over time. 22% of patent cases from % of patent cases from Colleen Chien, Of Trolls, Davids, Goliaths, and Kings: Narratives and Evidence in the Litigation of High-Tech Patents, 887 N.C.L. Rev. 1571, 1572 ( ) NPEs typically assert multiple patents where each patent has been issued for 8+ years. NPEs often sue multiple defendants in the same litigation (or simultaneously).

18 Customer: Economics of Litigation 18 EC = P*DM + CD Expected Cost of Litigation (EC) Probability of Patent Holder Success (P) Expected Damages Amount if Patent Holder Successful (DM) Cost of Defense (CD)

19 Customer: Economics of Litigation 19 From the stand point of a one-time defendant such as a customer, it is rational to settle a case where the settlement amount ( SA ) is less than expected cost of litigation ( EC ) SA < EC

20 Customer: Economics of Litigation 20 EC = P*DM + CD No Merits. P= Zero (0). EC = CD SA < CD Even where patent holder has no chance of success, the customer is incentivized to pay money to patent holder. Overpayment to NPEs for weak patents.

21 Customer: Economics of Litigation 21 Cost of Defense Patent Litigation $1-$25M in Dispute End of Discovery: $1.5 Million Inclusive of All Costs: $2.5 Million Patent Litigation More Than $25 Million In Dispute End of Discovery: $3 Million Inclusive of All Costs: $5.5 Million AIPLA Report of the Economic Survey (2009)

22 Manufacturer 22 Manufacturer more likely to take broader view relating to the impact of litigation than customer. Manufacturer more likely to focus on: Current and future population of customers Current and future products that use the accused technology Manufacturers competitors and impact on competition Design Around options Royalty Stacking and impact on profitability

23 Manufacturer: Economics of Litigation 23 EC = P*DM + CD (1-P)*B Expected Cost of Litigation (EC) Probability of Patent Holder Success (P) Expected Damages Amount if Patent Holder Successful (DM) Cost of Defense (CD) Benefit of Litigation (B)

24 Manufacturer: Economics of Litigation 24 EC = P*DM + CD (1-P)*B No Merits. P= Zero (0). EC = CD B SA < (CD B) For manufacturers, the benefits of litigation could exceed the cost of defense for an individual case. As a result, there may be no incentive to pay patent holder.

25 Manufacturer: Benefits of Litigation 25 Claim Construction Order Road map for Design Around to eliminate future patent exposure; or Provide clear non-infringement argument. Protection of Customers / Prevention of Serial Litigation Reduce exposure to additional indemnification and indemnification claims (e.g., limits CD to a single case). Improve Settlement / Licensing Position Negotiate licensing terms consistent with economics of the manufacturer.

26 Manufacturer: Benefits of Litigation Patent settlement / licensing offers are often priced in the following manner: 26 SO = RR * PS * D SO = Settlement Offer RR = Royalty Rate PS = Projected Sales of Infringing Products From Notice of Infringement to Patent Expiration D = Settlement / Time Discount

27 Manufacturer: Benefits of Litigation 27 Design Around can substantially reduce projected sales and the time period for potentially infringing sales. For a patent with 7 years of potential damages from filing of lawsuit, a design around implemented 2 years from the filing of the complaint would eliminate 5 years of potential damages. B = (PS-PSD) * RR * D SO = RR * PSD * D PSD = Projected Sales of Infringing Products From Notice of Infringement to Implementation of Design Around Expiration

28 Manufacturer: Economics of Litigation 28 EC = P*DM + CD (1-P)*B No Merits. P= Zero (0). EC = CD - B SA < (CD B) Where B > CD, manufacturer has little or no incentive to pay NPE for weak patents.

29 Patent Holder Complaints Re: Exception Plaintiff s should be able to license (and pursue damages) on the complete system as opposed to manufacturers components. Reasonable Royalty on $100 system as opposed to $5 part. 2. Customer suit exception forces patent holder to license component manufacturer and may result in patent exhaustion. 3. Courts should not second guess plaintiff s choice of defendants and forum.

30 New Test for Customer Suit Exception 30 Test Is the manufacturer the true defendant in patent case filed against customer? Three-Factors o Is the manufacturer's product central to the patent holder's infringement allegations because it "substantially embodies" the accused features of the customer product? o Does manufacturer have duty to defend and indemnify customer? o Is the manufacturer case likely to resolve the major liability issues with respect to an asserted patent and manufacturer s product?

31 New Test for Customer Suit Exception 31 No requirement that the manufacturer case be filed in a different forum. The test is applied on a patent-by-patent basis. No requirement in eliminate patent claims with respect to all the customer defendants.

32 Patent Holder Complaints Re: Exception 32 Frequently, a key issue will whether the patent holder infringement allegations are directed to a customer's "system" or the manufacturer's component. By focusing on whether the manufacturer's product substantially embodies the accused features of the customer product will assure that stay is only applied in cases where the manufacturer's technology is central to the case. The part of customer product not provided by the manufacturer cannot result in elimination of manufacturer s indemnification obligations to customer.