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Hi, I’m Brad Feld, a managing director at the Foundry Group who lives in Boulder, Colorado. I invest in software and Internet companies around the US, run marathons and read a lot.

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Software Patent Absurdity

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As long time readers of this blog know, I’m strongly against software patents.  Succinctly, I think they are (a) invalid constructs, (b) totally unnecessary, and (c) a massive tax on and retardant of innovation.

More and more of my VC brethren are beginning to come out publicly against them as are many extremely well respected long time software innovators.  So I was amazed to start hearing a statistic being thrown around that 76% of Venture Capitalist Believe that Patents are Important.  My partner Jason Mendelson dug in, figured out what was going on, and wrote a very important post titled 76% of Venture Capitalists Believe that Patents are Important (NOT!) explaining that it’s a totally invalid conclusion from a recent study.

In additional “c’mon guys, software patents are invalid” news, there’s a great short movie that was supported by the Free Software Foundation called Patent Absurdity.  It explores the case of software patents and the history of judicial activism that led to their rise, and the harm being done to software developers and the wider economy.  

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The film is based on a series of interviews conducted during the Supreme Court’s review of in re Bilski (which I attended in person) — a case that could have profound implications for the patenting of software.  It’s really good and worth 29 minutes of your life.

Butterflies All The Way Down

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When I saw this a few minutes ago as I trolled through my daily folder, I thought of an email I got yesterday titled “turtles all the way down” that referred to an article yesterday on TechDirt titled What If The Very Theory That Underlies Why We Need Patents Is Wrong?  The article discusses a new paper out by my MIT advisor Eric von Hippel and his Harvard Business School colleague Carliss Y. Baldwin titled Modeling a Paradigm Shift: From Producer Innovation to User and Open Collaborative Innovation.

I expect this to be a key paper cited in the ongoing debate about software patents (and patents in general).  Anyone in the software industry will quickly understand this paper and the massive shift we’ve seen from a “producer innovation model” to a “open single user and open collaborative initiative model” of innovation. 

In the mean time, here are the butterflies.

See Explanation.  Clicking on the picture will download
 the highest resolution version available.

What do you think this is?  I’ll give you a hint – the little white line in the left corner is a scale that represents 5,000 km. 

The Typical Kinds of Software Patent Plaintiffs

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Yesterday I published one of Sawyer’s posts titled Why the Decks are Stacked Against Software Startups in Patent LitigationIn it, I realized that Sawyer hadn’t defined the different types of plaintiffs in a patent case.  Below are good definitions (from Sawyer) of each type and clear explanations about what you are up against in each one.

If you’re sued in a software patent case, the first thing you should do is figure out what kind of plaintiff you’re up against, because that will have a major impact on your negotiation posture, and you will almost surely want to settle out sooner rather than later.

One important prefatory note has to do with contingent fee arrangements.  Most software patent plaintiffs hire their lawyers on contingent fee.  Depending on the state, the contingency can be anywhere from 30-40% of the final dollar amount exchanged between the parties, and it’s usually taken off the top.  This arrangement gives the lawyers powerful incentives to (1) push the case toward its maximal outcome and (2) not do any work on the case if they don’t have to.  So, if you think you have a contingent fee suit on your hands, know that you’re not just negotiating with the other side, but also with the lawyers who, both in front and behind the scenes, may be trying to undermine a resolution that they don’t feel is significant enough financially.

Now, here’s my non-exhaustive classification of types of software patent plaintiffs:

The active competitor:  These are the IBMs and Apples of the world, the active, money-making companies that get patents and sue their competitors for market advantage.  Competitor cases are usually not on contingent fee because the plaintiff doesn’t want money, it wants a more intangible advantage in the marketplace.  Between big players, these cases are often settled in cross-license arrangements, but one can imagine cases like Apple v. HTC being taken straight to trial because the plaintiff wants nothing more than to wipe out or diminish the defendant.

The defunct competitor or pseudo-competitor:  Many startups in the dot-com era filed for and got patents on things that we now would consider silly or obvious.  As those companies went under, or go under now, the entity that ends up with the companies’ assets seeks to monetize whatever is left, which usually ends up being the patents.  These companies morph from going concerns creating stuff to pure licensing entities that proceed to sue every player in a particular market sector.  These case are often on contingency because the plaintiffs can’t pay hourly.  Settlement strategies vary widely in these kinds of cases, but usually the plaintiff will be incentivized to push every suit to its rational limit unless someone comes along to vigorously defend against the patents.  These, in my experience, are the cases startups get caught up in the most, because the plaintiff doesn’t want to sue big players who can defend themselves (the patents are usually pretty bad), and so decides to extract as much value out of small companies in a particular sector as it can.

The “small fry” troll:  Here’s the strategy – I have a patent, and I want to collect money to fund some serious suits against big players.  What I do is find dozens of small companies (and by small I mean even made up of two people) and I sue them all in one suit, or several suits.  I have my lawyer play “nice guy” and offer to settle each plaintiff out for anywhere from $30k-100k, depending on company size.  At the end of the day, I’ve collected several million dollars and I can roll that money into suits against the big companies.  The reason the defendants settle is that they can’t afford to litigate the case out for a few months, let alone to trial, so they’re stuck and have to pay something.  I won’t call it extortion, but I guess I just did.  These cases are also sometimes on contingency, but the plaintiff usually hires very inexpensive counsel, with no intention of litigating the case, and those lawyers are fine with the relatively small payouts they get from small settlements.

The fund troll:  Many patent suits these days are backed, if you can figure out who the backers are, by specialized funds.  These are “venture funds” that collect money from LPs like traditional investment banks and use that money to identify and buy promising patents and set up/manage litigation against significant players to “make” the fund.  These cases are sometimes on contingency, and usually on partial contingency with capped fees (half of fees paid, with a 15-17% contingency).  The guys running these suits from the funds are usually very sophisticated, and have very specific ways of evaluating cases and deciding settlement amounts.  They usually won’t sue anyone too small to defend themselves, because it doesn’t make financial sense.  They also don’t let their lawyers influence settlement discussions.  In my experience, they are the most reasonable people to deal with in settlement, but at the end of the day you’re still paying the toll.

The “big fish” troll:  Sometimes there are software patents out there that have no good invalidity defenses, and where infringement by major players is very likely.  These are the holy grail for plaintiffs:  big, valuable, winnable cases.  The number of firms who handle these types of cases is very small, and one in particular has been racking up huge wins down in Texas for a few years now, especially the past year or two.  The plaintiff could be a specialized fund, or just an individual inventor; regardless, the plaintiff and the lawyers are perfectly aligned in wanting to litigate the case through trial.  If you see one of these firms, it’s a signal that they did their homework and think they have a very good shot at winning several hundred million dollars against some major player in the case.  The chances of settling these types of cases for anything less than eight figures is basically nil.  If you’re ever on the other side of a case like this, be afraid.

There are other “types” of software patent plaintiffs, but I think they draw characteristics from the types above.  The key takeaways, I think, are (1) that as a defendant, you’re negotiating both with the plaintiff and with the lawyers and (2) the suits aren’t usually filed by “real” businesses, so it’s generally hard to reach fair business-driven settlements.  Favorable settlements tend to happen only when a defendant is prepared to litigate a case to the end, and in discovery produces some very solid prior art and information on good non-infringement defenses.  This ends up being a function of the ability of the defendant to pay its own legal fees, so at the end of the day, settlements are based much more on the ability of the defendant to pay than the merits of the case.

Why the Decks are Stacked Against Software Startups in Patent Litigation

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The conventional wisdom has long been that software startups benefit from patents.  I’ve been investing in software / Internet companies for over 16 years and I’ve never once had a patent influence my investment decision.  More importantly, since it takes a number of years to get a patent, most startups haven’t even contemplated applying for a patent when they raise their first angel or venture round.  Our friend Sawyer has seen this first hand and has some specific thoughts on what they decks are stacked against software startups in patent litigation.

Software startups are particularly vulnerable to patent suits, and often are in jeopardy of losing their businesses entirely after being sued.  I think it’s important for everyone to understand the dynamics involved, because knowing why and how startups can be sued into oblivion will give you a new appreciation for the problems in the patent system.

A typical one patent case costs approximately $5 million to litigate through the end of trial, according to data that isn’t available online for some reason (the lack of pricing transparency in attorneys’ fees is a topic for another time).  Costs vary wildly depending on where the case is, how complicated the technology is, who the firm involved is, etc, but $5 million is a decent estimate all-in-all.

I’m sure you can already see the problem.  What software startup has $5 million to burn on defending a case with no value-add?  Even $500k?  I’d say it takes $1-2 million or thereabouts just to get through claim construction, which will give the parties a better sense of the overall merits of the case.  One patent suit with a slightly determined plaintiff could very easily end a software startup just in legal fees, let alone the impact of the suit on gathering customers in the future.

So, software startups have to settle patent cases very early, and at high settlement amounts, because they have absolutely no leverage.  Invalidity takes years to litigate, so you can’t threaten to invalidate the patent; same with inequitable conduct.  Non-infringement arguments are great in theory, but the plaintiff won’t have a judgment day until the middle of the case at the earliest, after claim construction, when summary judgment motions are allowed (on most schedules), and that’s several years of litigation and several million dollars away.  The defendant could file for a re-exam, but once it’s filed, the defendant has no control over it, and it takes a few years to get through the PTO.

Software startups sometimes have other leverage points, like the value of publicly shaming the plaintiffs, but when software patent NPEs are backed by investment funds through seven layers of corporate shell companies, or are dead companies with nothing to lose, who can you shame?  And does anyone particularly care?  The average person thinks patents are property (not entirely true) and a “great thing” for the economy; heck, our elected representatives say the same thing all the time.

The bottom line is that, in a world where a few million dollars and several months of work can build a promising software business, albeit one without serious cashflow, a patent suit can stop progress and kill those companies very quickly.

Luckily, perhaps, plaintiffs want money, and so in most cases it’s not worth it for them to sue a company with no revenue.  But sometimes it happens, and it seems to be happening now with more frequency.

Startups can and do usually settle these cases, it’s just that the amounts paid aren’t particularly fair or a reflection of the value of the patents (generally nil); rather, it’s a reflection of a patent litigation system that only allows the huge players to defend themselves.  Everyone else?  Well, they’re kind of screwed.

Sawyer on The Notion of Willful Infringement

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Tonight, during Lost, I tried to decide just how “willful” Locke-the-smoke-monster was being.  I didn’t reach a conclusion – and doubt I will until the end of the season.  In the mean time, my anonymous lawyer friend known as Sawyer sent me a nice essay on the notion of “willful infringement in the context of patents.”  He also sent me some interesting comments about how pissed off a bunch of biotech patent lawyers were today are at U.S. District Court Judge Robert W. Sweet for invalidating seven patents related to the genes BRCA1 and BRCA2, but that’s not what this essay is about.  Remember, no matter how sensible Sawyer’s advice is, none of this is legal advice and, if you have a specific issue, make sure you spend lots of money on your lawyers since they also have to eat.  Sawyer’s comments follow.

One of the issues that seems to most concern developers in software companies is whether they should ever look at a patent, and if they do, whether they are "tainted" by the exposure (a patent virus, perhaps?).  The basic wisdom is that developers should avoid looking at or reading any patents, and I think that’s generally right, but the law isn’t as bad as it sounds.

There are two issues springing from exposure to a patent – the ticking off of the damages period for infringement of the patent, and willful infringement.  The first issue is relatively easy:  in order for a patentee to begin accruing damages, he must put a potential infringer on notice of his alleged infringement with some level of specificity.  The requisite specificity is a thorny legal issue, but it’s not just enough to send someone a patent, a patentee must also make an allegation of infringement by something (so, the theory goes, the alleged infringer can stop infringing).  Patentees can also sell products embodying the invention and mark them with the patent number, which counts as constructive notice, usually.

The second issue is the one I want to focus on.  The definition of willful infringement and its legal requirements have changed a lot over time.  It used to be something akin to "continuing to infringe when you knew someone was accusing you of infringement."  Under the current legal regime, the alleged infringer must continue to infringe in a manner that is both objectively and subjectively reckless (the law is still muddy and some will quibble with my framing of the test, but this is roughly it).  Objectivity in law means from the perspective of a hypothetical "reasonable man" (a legal fiction if there ever was one); subjectivity means from the perspective of the accused himself, i.e., that he believed or should have known that what he was doing was reckless and did it anyway.  The idea is that if there are strong reasons for people to think that an accused infringer does really infringe, e.g., because there are weak litigation defenses, then his continued infringement is willful; but it isn’t enough to infringe just with mere knowledge of the patent, or even because of negligence in figuring out whether one infringes.

The upshot is that just being exposed to a patent, and then later accused of infringement, isn’t anywhere near enough to be "willful," and so developers shouldn’t be too worried if they run into something accidentally.  That said, exposure to a patent is evidence that can come in at trial, and plaintiffs will use even tenuous exposure to paint a picture that could cause a jury to find willfulness even in the absence of solid, legally cognizable, evidence.  So, people involved in a software business should probably still avoid patents (not the least of which because they’re often incomprehensible anyway), just to be safe.

Also, one more note:  People think that a finding of willfulness means automatic treble damages, but the decision to enhance damages at all is discretionary with the trial judge, and he can choose to make no enhancement at all, or enhance to a level significantly less than treble.  The real problem with willfulness is that it gets "black hat" stories about defendants in front of juries, which taint them against a defendant regardless of the merits – it’s easier to think that someone infringes if he’s just a bad guy anyway, especially if the technology is boring and the patent is hard to understand.

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