Often patents are purchased and then later asserted by the purchaser/plaintiff in patent infringement litigation matters. With some frequency, attorneys, business people, and damages experts have attempted to meaningfully compare the purchase price of a patent to the damages being sought by the plaintiff associated with the same patent in patent infringement litigation (“Litigation Damages Value”). Courts have also been asked to consider whether the purchase price of an allegedly infringed patent should somehow limit the amount of patent damages that can be sought as a result of the infringement of that same patent.
One such example arose in the Spectralytics, Inc. v. Cordis Corporation matter (649 F.3d 1336, 1340 [Fed. Cir. 2011]). In this suit, the defendants argued that the relatively low purchase price for the allegedly infringed patent should preclude plaintiffs from asking for a 5% royalty, which, when applied to the relevant royalty base, caused damages to greatly exceed the prior purchase price of the patent. In this matter, the district court found that the jury could have reasonably concluded that the sales price had little to do with the outcome of the hypothetical negotiation setting the royalty rate. The Federal Circuit agreed that the 2003 sales prices did not render a 5% royalty unreasonable because the value assigned to the subject patent in 2003 reflected a very deep discount because Spectralytics “hoped that the patent would survive any challenge to its validity, but Spectralytics did not really know for certain, and it could not really know for certain without paying millions of dollars in legal fees to launch lengthy and risky litigation. . .”
Symantec and Trend Micro, as reported in a Reuter’s exclusive dated October 29, 2013, advanced a theory related to a $310 million damages claim asserted against them by Intellectual Ventures based on the purchase price of the patent at issue. The defendants asked a federal judge to bar Intellectual Ventures from seeking such large licensing fees on the grounds that a patent acquired for only $750,000 couldn’t possibly be worth so much from a damages perspective. In court filings and at a hearing in August 2013, Symantec and Trend Micro lawyers argued that the law prohibits Intellectual Ventures from calculating such a high royalty. They argued that a patent license is, by definition, less valuable than outright ownership of a patent.
Even more recently in January of 2014, in the United States District Court for the District of Delaware, as part of the Robocast v. Microsoft matter, the damages expert for Microsoft argued that the purchase price of the patent at issue in the case was relevant and limiting to damages. The judge, responding to a Daubert challenge of Microsoft’s damages expert, appeared sympathetic to the Microsoft expert’s arguments. The judge’s opinion states that the patent purchase, “serves as a relevant data point in determining the value which the parties to the hypothetical negotiation would place on technologically similar patents, in this case the Robocast patent at issue.” Referring back to the Spectralytics matter, the court indicated that, “There, as here, the value assigned to the sale would have reflected a discount, but “[t]he district court observed that the weight to be given to this aspect was a task for the jury.” The judge in the Robocast matter left it up to the jury to determine the weight accorded the valuation.
This article describes some of the different considerations surrounding a patent purchase versus a litigation damages analysis that may result in significantly disparate conclusions of value.
Patents may be purchased for many reasons. For instance, the purchaser may want to build products incorporating the new invention (i.e., freedom to operate). On other occasions, the purchaser may be seeking to preclude others from competing (i.e., right to exclude). Alternatively, the purchaser may want the patent for defensive reasons as it fears a possible suit for infringement of other patents and wants some “ammunition” to use in its negotiations or counterclaims (i.e., defensive value). In still other instances, the patent purchaser may want to use the purchased patent to license or sue currently identified or expected infringers (i.e., offensive value).
For purposes of this article, unless explicitly identified as otherwise, we are assuming a situation where a patent is purchased and later used by the purchaser/plaintiff as part of an “assertive” (i.e., “stick”) licensing monetization strategy that may potentially lead to litigation. Such a description can apply to various types of purchasing organizations, many of which may be referred to as non-practicing entities (“NPE”). This assumption is made because this common situation may lead to confusion as to why the patent purchase price may differ from the Litigation Damages Value.
There are many factors impacting why the purchase price of a patent may differ from Litigation Damages Value. These factors include:
Of course, the purchaser of a patent must negotiate its price with the seller. Neither the buyer nor the seller can unilaterally determine the value of the patent for purposes of the transaction. However, buyers can and do set maximum amounts they are willing to pay and, as part of the price-setting process, normally consider the expected Litigation Damages Value of the patent as part of their determination of the patent’s licensing potential. A purchaser/plaintiff will normally expect the Litigation Damages Value to cover at least its purchase price for the patent, its litigation costs, and to provide enough additional cash flow for the purchaser/plaintiff to make an appropriate risk-adjusted return on its investment. More specifically, potential buyers consider, among other factors, information such as the following: the probabilities of licensing without litigation, the odds of litigation success, the costs of litigation, required returns on the patent purchase price, and other qualitative and quantitative factors. The buyer can and should walk away from the transaction if the potential financial rewards are not perceived to be sufficient as a result of an unacceptably high purchase price being sought by the seller.
The seller is understandably trying to maximize the selling price of the patent and likely will not accept an offer below the value of their achievable next best alternative offer.
Factors that typically increase the difference between the patent purchase price and the Litigation Damages Value
In litigation a patent is assumed valid and infringed—both assumptions are hotly contested in patent purchase negotiations
Based on established court precedent, when patent infringement damages estimates are presented to the court, the plaintiff’s and defendant’s damages experts will assume, for the purposes of their analysis, the patent to be valid and infringed despite the fact that both validity and infringement may be hotly contested in the litigation. This assumption is in stark contrast to the patent purchase scenario where the purchaser will often express concern as to both the validity and infringement of the target patent and will typically discount the price of the patent to account for possible invalidity and/or non-infringement, among other issues. This concern, based on empirical data, is completely justified. For instance, studies by PricewaterhouseCoopers (“PwC”) place non-practicing entity (“NPE”) litigation success rates in patent infringement litigation at about 25%. This statistic does not include the many patents purchased, which, for one reason or another, are never asserted against anyone. It also does not indicate that the plaintiffs were awarded the damages they sought 25% of the time but simply that they were on the prevailing side in the litigation. Thus, as determined through the courts, the patents being asserted were either invalid and/or not infringed approximately 75% of the time. Further, discounting of the purchase price at a rate higher than 75% would be required to reflect patents which may never be asserted and litigation proceeds that may be lower than anticipated by the purchaser/plaintiff, among other reasons.
Based on validity/infringement considerations alone, a purchaser/plaintiff would pay, on average, less than 25% of the expected Litigation Damages Value to purchase the subject patent in order to just break-even (i.e., the purchaser/plaintiff would make no profit for the significant risks they are taking). Therefore, considering only this factor, if the purchaser/plaintiff expects to earn $10 million from successful litigation (assuming validity and infringement) then it should spend no more than $2.5 million, on average, to purchase the patent.
The time value of money
Patent licensing and/or litigation takes time, often significant amounts of time, and current trends appear poised to increase the time needed to resolve a licensing negotiation or patent assertion process. If a reasonable, simplifying assumption is made that the NPE plaintiff/purchaser would need one year to: (1) fully analyze its purchased patent, and identify and map infringement, (2) prepare and begin to implement license negotiation and litigation strategies, and (3) file a complaint, and also an assumption is made that the discovery, trial, and appeals process would take another three years (average length of patent litigation per the PwC Patent Litigation Study), then the purchaser/plaintiff would earn no return on its investment in the patent for four years. If an illustrative required rate of return for the purchaser/plaintiff of 15% per year is assumed, then the purchaser/plaintiff would need to receive about $175 for every $100 it invested in order to just earn its risk-adjusted return on its investment. Another way to look at these same economics is that if the purchaser/plaintiff expected to earn $10 million four years after its purchase of a patent then they should be willing to invest only $5.7 million to purchase the patents (not including amounts spent to litigate the patent and the required return on the litigation investment) in order to earn its assumed required risk-adjusted rate of return of 15%. Based on this factor alone, if the purchaser/plaintiff expected to earn $10 million from successful litigation, then it should spend no more than $5.7 million to purchase the patent.
The cost of litigation
In addition to reducing the patent purchase price for the probabilities of losing the litigation, the purchase price of the patent has to be low enough to allow a risk-adjusted rate of return and to cover the costs of the litigation (along with a risk-adjusted rate of return on such costs). Reasonably assuming the winning purchaser/plaintiff is not awarded its litigation costs, the purchaser/plaintiff will have to pay litigation costs whether it wins or loses the litigation. Various reasonable assumptions could be made about patent infringement litigation costs likely to be incurred given various cost and settlement options possibly available to the purchaser/plaintiff. However, if for illustrative purposes, we assume that average litigation costs were incurred relating to a medium sized patent infringement litigation matter (assumed to be matters where damages sought are between $1 and $25 million), the purchaser/plaintiff would attempt to drive down its purchase price for the patent by the amount of the litigation costs rather than reduce its own risk-adjusted required return on its investment in the patent. Under the assumptions above, based on this factor alone, if the purchaser/plaintiff expected to earn $10 million as a result of successful litigation then it should only spend $10 million, less average medium-sized matter patent litigation costs of $2.6 million (AIPLA 2013 Report of the Economic Survey), or $7.4 million. In other words, based on this factor alone, the purchaser/plaintiff would attempt to reduce the purchase price of the subject patent by $2.6 million. If these litigation costs were assumed to occur equally over the assumed three year period from patent purchase to awarded damages then the purchaser/plaintiff should try to reduce its investment in the patent by another $0.693 million for a total $3.3 million purchase price reduction representing the out-of-pocket litigation costs plus interest.
Uncertainty and lack of information leads to conservative estimates that cause the difference between patent purchase price and Litigation Damages Value to increase
Although millions, and sometimes many millions, of dollars may be involved in purchasing patents by NPEs, the amount of information available at the time of the patent purchase is typically significantly less than the amount of information available by the time the purchaser/plaintiff presents its damages case in court. Because so much information is unknown or uncertain as of the date of the purchase of the patent, the purchaser/plaintiff will attempt to realistically measure its potential revenues and costs but will tend toward a conservative estimate of the revenue potential of the patent litigation while aggressively estimating the costs of the litigation. This process, reflecting uncertainty and lack of information, contributes to larger differences between the final patent purchase price and its Litigation Damages Value.
However, after the patent is purchased and during the litigation process, more and better information typically becomes available, thus reducing some of the purchaser/plaintiff’s uncertainty. For instance, subsequent to the patent purchase, the purchaser/plaintiff will often perform significant additional legal, technical, and business due diligence to be certain that the patent is “litigation-ready” (for example, developing detailed claim charts, exploring the details of the patent prosecution, and reviewing changes in legislation and case precedent). In addition, the passage of time allows new insights about infringers, market conditions, competitive companies and technologies, and more. However, often more importantly, a great deal of valuable new information comes from discovery of the defendant’s business and technical records. Through litigation discovery, the purchaser/plaintiff confirms the identity and volume of allegedly infringing products, the importance of the patented invention or feature to customer demand, the profitability of allegedly infringing products, estimated litigation costs, and much more.
Armed with additional information, the earlier lack of knowledge and uncertainty regarding damages is often reduced, allowing more fully supported and less conservatively estimated damages calculations. Thus, additional information obtained post-patent purchase will often lead to more refined and larger damages calculations by the purchaser/plaintiff, causing a greater difference between the patent purchase price and Litigation Damages Value.
Purchaser/Plaintiff may have been willing to pay more than it actually paid for the patent
The market to buy and sell patents is not “efficient” in the economic sense. Patents offered for sale are not homogenous as they would be in efficient markets reflecting the fact that patents are, by definition, unique. For each patent, there is only one seller and often there are only a few potential buyers, sometimes only one. Information about the invention and its potential is not instantaneous, accurate, complete, or even symmetrical (i.e., buyers and sellers often have fundamentally different views of the value of the patent). In addition, the markets do not feature ease of entry or exit. Consequently, competition may be modest to purchase a particular patent or group of patents. In addition, buyers often have more options, greater financial resources, and more time available to consider a transaction than sellers. On top of these considerations, many NPE buyers of patents for assertive licensing or litigation purposes are often, through education and substantial experience, highly skilled negotiators. And, of course, it is typically a goal of the purchaser/plaintiff to pay as little as possible for the patent it is seeking. As a result of these and similar factors, purchasers/plaintiffs are often not pushed or compelled by competition to pay “top dollar” for a patent. To the extent the purchaser/plaintiff underpaid for the patent this will increase the difference between the patent purchase price and its Litigation Damages Value.
Not all terms and conditions of the patent purchase may be available or understood
Care should be taken in comparing patent purchase prices to Litigation Damages Values to ensure that all purchase terms and conditions are understood and the value of which have been accounted for. For instance, it is not uncommon that the seller of a patent will negotiate some participation in the upside of the subsequent licensing or Litigation Damages Value of the patent and will grant, in exchange for its participation in the upside potential, a lower purchase price for the patent. Similarly, many patents are sold subject to pre-existing licensing and/or cross-licensing agreements, which potentially constrain (1) the ability to license and (2) the value of licenses or litigation in the future. Unless all terms and conditions of a particular patent purchase are available and well understood, the apparent gap between the purchase price of the patent and the Litigation Damages Value of the patent can be overstated.
Factors that typically decrease the difference between the patent purchase price and the Litigation Damages Value
A patent that can be litigated against multiple defendants will, others things being the same, be more valuable than a patent that can be litigated against only one defendant.
A patent with broad and general claims can sometimes be the basis for infringement actions against multiple alleged infringers. Assuming that the purchase price of a patent is typically lower than the Litigation Damages Value of the same patent as described earlier, certainly in situations where the purchaser/plaintiff expected the patent to be the basis for multiple lawsuits (instead of one lawsuit in our earlier examples) and paid for the patent based on that expectation, a collection of multiple defendants would tend to close the gap between the purchase price of the patent and the Litigation Damages Value of the patent in any single lawsuit.
For practicing entities, a patent may have value from litigation and also value from internal or defensive uses.
To the extent that patent value exists which is unrelated to litigation, such as value from internal use or value from defensive use, such components of value would tend to reduce potential differences between patent purchase price and Litigation Damages Value.
Competition can drive up the patent purchase price
By way of example, it is widely believed that competition among several buyers pushed the value of the Nortel Networks portfolio significantly above the expectations of most observers prior to the auction. In contrast, Kodak’s portfolio sold for less than expected by many observers because key buyers combined into a single buying group as opposed to the several powerful and competing buying groups that were seeking the Nortel Networks portfolio of patents.
Factors that may increase or decrease the difference between patent purchase price and Litigation Damages Value
Results of new information
Additional information obtained after the patent purchase can either increase or decrease the difference between the purchase price of the patent and its Litigation Damages Value. Significant negative information affecting the Litigation Damages Value of the patent is often discovered after the patent is purchased. Examples of significant negative information would include the following, along with many others:
Changes in market conditions
Changes in market conditions such as competitors entering or leaving the market, new legislation or regulation, product safety issues, etc., can either increase or decrease the Litigation Damages Value of a previously purchased patent and, therefore, can increase or decrease the difference between the purchase price of the patent and the Litigation Damages Value of the patent.
Updating the Intellectual Ventures v. Symantec and TrendMicro Case
In the introduction above, we introduced the Intellectual Ventures v. Symantec and TrendMicro matter and summarized the defendant’s arguments as to why the litigation damages should be constrained by the purchase price of the patents. In March of 2014, the court, as part of its ruling on a Daubert motion against the plaintiff’s damages expert, agreed that the purchase price was not a limiting factor on damages citing four reasons:
The purchase price of a patent can often be significantly different than its Litigation Damages Value. By identifying and considering factors such as those mentioned above that can increase or decrease the difference between the purchase price of a patent and its Litigation Damages Value, we hope we have provided some considerations that can be evaluated if patent purchase price is raised as an issue in patent litigation.
Finally, patents are valued for many reasons in addition to just patent purchase for litigation use. Other patent valuations can be performed for reasons such as: strategic decision making, transaction support, tax support, compliance, financial reporting, value of assets as collateral and other reasons. Litigation Damages Value is uniquely determined for, and reflective of, the litigation environment and a particular identifiable user or users of the patented technology. Depending upon the facts and circumstances of a particular matter, the purchase price of a patent may or may not be a relevant input to a damages determination. However, it is important that anyone comparing a Litigation Damages Value to the valuation of the same assets in a different context keep in mind the potentially differing circumstances, goals, assumptions, methods, timing, and requirements underlying each valuation.