The US Federal Trade Commission (FTC) has peeled back the financial records of patent assertion entities (PAEs) to dissect their business model and propose changes that might curtail the abuse it causes. In a study released in October 2016, the FTC provides valuable data about how PAEs operate. This knowledge can help businesses better defend against claims asserted by PAEs as well as develop better strategies for dealing with PAEs generally.

The study involved 22 PAEs that collectively generated $4 billion in licensing revenue over 2,715 license agreements from January 1, 2009, to September 15, 2014. The first of its kind, this look into the PAE business model identified key difference between two basic types of PAEs, revealed general trends in assertion strategies and offered recommendations for limiting the harm caused by PAEs.

The study divided assertion entities into two types. The first type, “Portfolio PAEs,” typically assert large portfolios that include hundreds (or even thousands) of patents. Portfolio PAEs seldom sue the accused infringer. The second type, “Litigation PAEs,” often sue multiple parties at the same time and extract quick settlements, typically with just a handful of patents.

Portfolio PAEs were fewer in number and had far fewer settlement agreements than Litigation PAEs, but they still dominated the revenue generated in the studied period. Of the $4 billion in licensing revenue examined in the study, Portfolio PAEs accounted for around $3.2 billion. Despite having the lion’s share of the licensing revenue, Portfolio PAEs accounted for just one out of every twenty-five of the cases filed and just under one out of ten of the licenses negotiated.

Beyond the stark contrast in revenue generated per license between the two types of PAEs, the study also revealed other differences. For example, Portfolio PAEs were “highly capitalized,” while Litigation PAEs “generally operated with little or no working capital.” Portfolio PAEs obtained less than a third of their licenses after filing an infringement suit, while Litigation PAEs—as their name implies— negotiated nearly all of their licenses (nine out of ten) only after filing suit. The length of the lawsuits also differed drastically: about three-quarters of cases filed by Portfolio PAEs lasted more than a year, compared with only about a third of cases filed by Litigation PAEs.

Although the study could not accurately compare the amount of payments that inventors received from PAEs’ licensing efforts, the FTC did find that about half of Litigation PAEs relied exclusively on revenue-sharing agreements to acquire their patents. All of the Litigation PAEs involved in the study reported that at least some of their patents were subject to some form of a third-party financial interest, while half of those in the study reported that all of their patents were subject to a third-party financial interest.

The study confirmed that PAEs target not just manufacturers but also end-users of products, such as retailers. Companies in the electrical and electronics industry made up the majority of the targets: software-related patents accounted for over three-quarters of the holdings of the PAEs that were analyzed.

The study “recommend[ed] that policymakers address PAE litigation asymmetries through procedural and substantive reform,” calling for several changes to lessen the economic burden caused by PAEs. The FTC’s recommendations included:

  • Amending Rule 26 of the Federal Rules of Civil Procedure to account for the asymmetrical costs of patent litigation for PAEs and practicing entities;
  • Promoting the early disclosures of asserted patent claims, infringement contentions and damages theories;
  • Expanding the disclosure of relationships under Rule 7.l to better expose the financial relationships shared by PAEs;
  • Enacting provisions that encourage courts to stay actions against end-users while a suit involving the same patents is pending against manufacturers; and
  • Requiring more detailed pleadings with more particularity in order to put accused infringers on notice and to provide them with more information with which to evaluate a PAE’s accusations.

Armed with a better understanding of how PAEs operate, accused infringers can better defend themselves by exploiting the weaknesses of the PAE business model in the following ways.

  1. Shift the balance. Particularly for Litigation PAEs, most of the advantage comes from the highly asymmetrical cost of discovery between PAEs with few relevant documents and accused infringers with hundreds of thousands of pages of sales information, technical drawings and marketing materials. However, the study reveals that PAEs depend on quick settlements from defendants who choose to pay patentees instead of lawyers. Early, detailed discovery requests, motions to dismiss or transfer or even motions for judgment on the pleadings in extraordinarily weak cases all derail the PAE business model.
  2. Scrutinize the pleadings. Now that form 18 has been removed from the Federal Rules of Civil Procedure, plaintiffs likely face a higher standard for their complaints. Though the law is still evolving in this area, an early-filed motion to dismiss for failure to state a claim may force PAEs to narrow overbroad infringement assertions and provide more detail about their contentions. This in turn creates more work for PAEs counting on the cost of discovery to deter accused infringers from fighting back.
  3. Put patentees in the “hot seat.” Accused infringers often miss the opportunity to inquire into the acquisition and ownership of the asserted patents as well as the corporate structure and ownership of patentees. Creative discovery requests that are no less overbroad than those propounded by PAEs might put patentees on the defensive and further balance the asymmetrical costs of patent litigation. This strategy might also limit a defendant’s exposure: an improperly drafted assignment agreement could cut into a PAE’s pre-suit damages.