PublishedDecember 5, 2012

Helping Startups Help Themselves: Why the SHIELD Act is TRIPS Compliant

(Cross-posted on Disruptive Competition Project (DisCo))

As I have discussed before, patent trolls pose a unique threat to technology startup companies.  The limited resources and small launch windows that constrain life as a startup company make them vulnerable to patent trolls.  Trolls leverage the sheer cost of fighting a patent challenge — even if the odds of winning are high — against the precarious situation of most startups and seek settlements.  Unlike established companies who can afford to take a long-term view and usually fight trolls at all costs to deter future troll lawsuits (aka “we do not negotiate with terrorists”), small startups do not have this luxury.  As Brad Burnham of the prominent VC firm Union Square Ventures has written, trolls seek to hit startup companies at the most vulnerable times, either right after they receive a major cash infusion — like Etsy and Hipmunk — or right after that startup announces that it is being acquired:

“By pouncing after the merger is announced, but before it closes, [patent trolls] hope to extort a quick cash settlement.”

There is a unique and discrete market failure at work here.  Since the majority of patent trolls lose when the case goes to court, companies should — and the big companies usually do — fight the baseless charges.  However, since startups are uniquely vulnerable — and bear the high costs of litigation even if they win — there is little incentive for them to fight these bogus suits and parasitic market actors (which, I may add, would have significant positive externalities as these trolls target many companies).  As a result, they often end up settling.  This is an unfortunate example of game theory where individual incentives don’t align with the public good.  Paulgb (who appears to be web developer Paul Butler) in a forum at Ycombinator summed up the situation nicely:

The patent trolls know that the rational (in the game-theory sense of the word) decision for the victim company is to settle, because the cost of taking it to court (in both legal fees and lost time) exceed the cost of the settlement.

It’s like an asymmetric game of chicken.  Both players know that the troll has the advantage of having less to lose in a “collision” (a lawsuit), so the troll can count on the victim to “swerve” (settle). If the victim was able to eliminate the cost of a collision, and the troll knew that the cost of a collision to the victim company was eliminated, it would make more sense for the troll to swerve (drop the claim).

Since the America Invents Act (the “AIA”) recently passed Congress after an excruciating multiyear journey — and in the end failed to address most of the systemic problems that plague the current patent system — there is little short-term hope or Congressional appetite for another major patent reform fight.  However, until the political capital refills, there are smaller, more discrete fixes that eliminate some of the worst abuses of the current patent system.

One of these, the Saving High-tech Innovators from Egregious Legal Disputes (or “SHIELD”) Act proposed by Rep. DeFazio (D-OR) and Rep. Chaffetz (R-UT), would help solve the market failure described above by making it easier for startups (and all tech companies) to recoup the costs incurred over the course of a frivolous court battle.  Changing the expected value of the final payout would incentivize more startups to fight trolls and bust their bogus patents.  There is a “public good” component at work here, as fighting these frivolous suits would help break trolls and bust their bogus patents before they turn on others in the industry.  (Lodsys is one particularly egregious example of this.)  This may benefit bigger companies as well, as trolls often use settlements from nuisance suits against startups to fund bigger, more ambitious lawsuits, as Burnham notes:

Trolls go after the smaller companies first. They pick on startups because undercapitalized small companies cannot afford to be ideological. When faced with the prospect of extensive legal fees and a huge distraction, they do the pragmatic thing – they settle. The troll can accept less from a startup because the troll can later argue the startup has a small market share and a limited ability to pay. A smaller settlement does not preclude larger settlements with bigger players later…

The trolls then use the money extorted from young startups to fund the more expensive and ambitious cases against larger more established companies with deeper pockets. These folks have more to lose but they also have more resources to defend themselves. I don’t often think about the plight of large companies but this attack has a direct impact on young companies.

Although the SHIELD Act is a no-brainer, some disingenuous criticism has arisen from those that profit from our out of control patent system.  They claim that the Act conflicts with our international trade obligations, most notably Section 27.1 of Trade-Related Aspects of Intellectual Property Rights Agreement (TRIPS), which states:

[P]atents shall be available and patent rights enjoyable without discrimination as to the place of invention, the field of technology and whether products are imported or locally produced.

They argue that because the SHIELD Act targets the industry where the problem is most acute — high-tech/software — that it violates the discrimination prong of TRIPS.

This is a red herring.  First of all, the WTO — which administers TRIPS as part of its charter — ruled that treating industries differently is not necessarily discrimination as long as there are “legitimate reasons” for doing so.*  Given that patent trolls are unique to high-tech markets — so much so that the DOJ and FTC are investigating them in a hearing next Monday in that context — there are legitimate reasons for focusing on software patents, which present their own unique set of problems.

Second, even if we take “discrimination” to mean “differentiation” (which, once again, the WTO said explicitly should not be the interpretation), then we — along with the European Union, and most other signatories to TRIPS — are already in violation.  (At least 11 TRIPS signatories don’t allow for software patents at all.)

In a great paper by Professor Colleen Chien (which is an SSRN placeholder for a larger paper on the subject), she shows that we already treat different inventions differently, including exempting surgeons from being found guilty of infringing patents on surgical methods, the drug patent Bolar exemption [35 USC § 271(e)], the prohibition of patents on tax strategies, and the singling out of business method patents for special post-grant review as part of the recently passed AIA.

Professor Chien’s list is not even exhaustive, as Jamie Love has pointed out other differential treatment in the past.  In fact, foregoing explicit differential treatment in a statute is not full protection from violating TRIPS as the WTO notes:

Discrimination may arise from explicitly different treatment, sometimes called “de jure discrimination”, but it may also arise from ostensibly identical treatment which, due to differences in circumstances, produces differentially disadvantageous effects, sometimes called “de facto discrimination”.

So, one could even could even argue that because there is already pretty clear “de facto discrimination” against the high-tech industry in how the current patent statutes have manifest themselves through jurisprudence and differential enforcement, that this bill would actually make us more TRIPS compliant.

As Professor Chien rightly points out:

There is no “legitimate interest” in imposing millions of dollars in defense costs based on a non-meritorious suit, or in racking up legal fees that far exceed the economic value of the patent, when a reasonable offer of settlement has been made.

Ultimately, the TRIPS point is a very peculiar position to take: that international law mandates a one-size-fits-all system, and therefore Congress is forced to permanently disadvantage one of our chief export industries.  This cramped reading would seem to be more of an indictment of the TRIPS Agreement than the SHIELD Act — which furnishes one more reason why it is an unreasonable interpretation.

Failing to pass this little bill that will do a lot of good — or even bring it to the floor for debate — under the flimsy contention that this would violate a flexible TRIPS commitment would be a travesty.  At the very least, Congress should make SHIELD Act opponents argue on the merits of this bill rather than mischaracterizing language in international trade commitments and characterizing the bill as non-starter.  As Bessen and Meurer have shown, the stakes of the patent troll problem are too high to let this bill die on fabricated deference to an international treaty.


* There has only been one WTO case interpreting Article 27 of TRIPS, the Canada-Pharmaceutical case (WT/DS114/R).  Although the decisions of the Dispute Settlement Body (DSB) of the WTO are non-binding, they are treated as a persuasive authority and serve as our best current guide to the thinking of the WTO on the interpretation of “differentiation” versus “discrimination” as contemplated by Article 27.  In fact, the Report of the DSB notes, “Article 27 does not prohibit bona fide exceptions to deal with problems that may exist only in certain product areas.”

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Dan O'Connor

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