NPEs planning patent litigation may be safer as private companies

Sunday, April 6, 2014

Note: I’m not your lawyer, you’re not my client, and nothing in this article is, or should be construed as, legal advice.

Companies that don’t sell anything and exist only to enforce patent rights, sometimes purchased from the original patent holder solely for the value of enforcement, are known as non-practicing entities (NPEs) or, pejoratively by defendant companies and their attorneys, “patent trolls.”¹

The NPE will sue claiming infringement of one or more patents, and may not actually have any intent to litigate. Many companies and inventors of all sizes regard NPEs scornfully, but are often forced to play ball because settlement is almost always cheaper than litigation. For smaller startups, the cost of litigation may even pose an existential threat.

Allow me to play devil’s advocate for a bit. I consider most NPEs parasites, siphoning money out of the market in return for nothing at all. But here are some thoughts on what some of them may be doing wrong from their own perspective. After all, what good is an attorney who can’t think like his enemy?

Let me explain some basic corporate law, as much for my recollection as for your edification. A corporation is subject to the law of the state in which it incorporates, and corporate law differs from state to state. The cases I cite below only illustrate the foundational principles of corporate statutory and common law.

A company’s board directors and officers owe several fiduciary duties to shareholders and the company itself. One of those is the duty of care, which says that responsibility for “the financial interests of others imposes on a director an affirmative duty to protect those interests.”²

However, courts realize businesspersons are in a better position than judges and attorneys to make sound decisions for their companies. For that reason, courts often defer to the judgment of a company’s leadership absent some gross negligence.³

The business judgment rule, as it is called, is at its core :

a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.⁴

Thus, the fiduciary duty of care owed to shareholders by directors and officers requires them to make a “good faith effort to be informed and exercise judgment.”⁵

So, now back to the NPEs. When a company faces suit by an NPE, its leaders are obligated to compare the costs of litigation and settlement and choose the path most protective of the company’s and shareholders’ interests, which is usually the less costly path. And that, of course, is almost always settlement.

Joe Mullin, writing for Ars Technica, explains the financial position of an NPE recently vanquished by web-based tech retailer Newegg:

MacroSolve had about $800,000 on hand and looked to be burning through about $50,000 a month, not including payments to its lawyers.

That $50,000 happens to match the low-end of the amount MacroSolve demanded of companies against which it brought patent infringement lawsuits. In other words, it matched its settlement demands to its burn rate.⁶

It was actually surviving only, or primarily, by threatening to go to trial on patent claims of dubious validity. MacroSolve is a public company, so much of their financial and operational information is openly available. Newegg realized after reviewing that information that MacroSolve’s burn rate matched the settlement demands, and built a strategy around it: call the MacroSolve bluff, revealed by their public financials, by refusing to settle, causing their burn rate to deplete cash-on-hand and substantially reduce or totally eliminate the company’s ability to press on with any outstanding litigation.

NPEs registered as private companies and considering the MacroSolve strategy may be safer staying private. Public companies may want to consider taking the company private before using litigation or threat of litigation, on the assumption that some percentage of defendants will settle, to fund the company’s survival.

In conclusion, patent litigation by non-practicing entities is even more a game of poker than most litigation, to the extent the defendant isn’t really infringing or the patent’s validity is assailable, and public companies show too much of their hand too much of the time to play safely under most corporate law regimes.⁷

#Law #Articles #Ars Technica #burn rate #business structure #corporate law #corporate structure