Patent Strategy Questions Raised By the eBay Decision

The effect of the Supreme Court's May 2006 opinion in eBay v. MercExchange is already visible in the world of intellectual property litigation. A handful of subsequent district court opinions relating to damages and permanent injunctive relief for patent infringement have been handed down with outcomes substantially outside of what would have normally been expected less than even a year ago, using the eBay decision as precedent. Although the true and long-lasting effect of this decision on litigation remains to be seen, its directional influence is clear. However, what is unclear is the effect that eBay will have on real-world intellectual property management and investment. The appropriate manner in which to react to these recent changes in the litigation realm is currently an area of much discussion by corporate IP departments, patent licensing and enforcement companies (P-LECs) and financiers.

In the unanimous eBay decision, the U.S. Supreme Court held that a plaintiff is not automatically entitled to a permanent injunction simply by proving infringement by the defendant. Prior to this, an automatic injunction was the de facto standard in the district courts, which granted injunctions in all but extraordinary circumstances. Instead, the Court affirmed a four-factor test to assess the appropriateness of a permanent injunction: 1) irreparable injury; 2) inadequacy of remedies at law; 3) balancing of hardships; and 4) the public interest. Because an analysis based on this framework requires some balancing of equities, in practice the decision is usually made by the presiding judge and not the jury. The concurring opinions issued in the eBay opinion address additional issues of importance to the business world. These relate to injunctions and P-LECs, university research, and business method patents.

In z4 Technologies v. Microsoft Corporation, heard before the traditionally pro-plaintiff Eastern District of Texas, the District Court issued an opinion in June 2006 denying z4's motion for a permanent injunction. It found that z4 would not suffer irreparable harm and also referred to the Justice Anthony Kennedy's concurrence that suggested a permanent injunction may be inappropriate in cases where the patented technology only relates to a small portion of the infringing product. In this case, the running royalty the court assigned for Microsoft's future use of the patented invention was equal to the reasonable royalty the jury awarded for past damages, simply applied to future sales. It is notable that the term of this compulsory license was a short one; as part of its argument against a permanent injunction, Microsoft cited the fact that the subject technology had already been designed out of its next generation product, which was due for release within the next year.

The following month, another motion for permanent injunction was denied in another Eastern District of Texas decision, Finisar Corporation v. DirecTV Group. Again, the opinion was based on an analysis of the four-factor test laid out in the eBay decision. Three differences between this opinion and that of z4 are particularly interesting. The first is that the Finisar patent claims did cover fundamental aspects of the infringing product. The second is that the compulsory license created by the court was for the remaining life of the patent. Third, the running royalty rate was decided by the judge, not the jury. The judge considered many factors in determining a fair royalty rate. These factors included the licensing history of the parties and industry practices, the relationship between the parties, the profitability of the parties, as well as expert testimony and the jury's damages award. It disregarded the finding that the defendant had willfully infringed on the patented technology.

Reflection on these opinions leads one to conclude, at least initially, that the eBay decision will in fact reduce the number of permanent injunctions granted by the courts. There are some that go so far as to believe that it may make them all but impossible to obtain by non-practicing/non-commercializing entities. In the absence of an injunction, a compulsory license is the only form of relief for IP owners. At this early stage, it does not appear that these licenses will be a windfall to owners, nor an undue hardship on infringers. However, this is based on only a handful of cases. Instead of providing clarity, many questions relating to the effect on the underlying value of intellectual property and the interrelationships between participants in the IP marketplace have arisen:

Should Companies Fight Longer and Harder Against P-LECs?

From the time of their inception until today, the business model of P-LECs (sometimes referred to as 'patent trolls') has depended largely on stick licensing and the threat of litigation. The eBay decision has, at least for now, appeared to dull the point on the end of that stick. Indeed, Justice Kennedy's concurring opinion specifically noted that permanent injunctions often should not be available to these types of entities. Although the prospect of paying court-awarded past damages and an ongoing future royalty is not pleasant, litigation is considerably less intimidating without the possibility of a business-halting court order, as RIM, the maker of the Blackberry', can surely attest. This is not to say that reaching an early settlement agreement with a threatening P-LEC is not without its advantages. The total amount of past damages and a future royalty can be substantial and difficult if not impossible to accurately forecast, as are the costs associated with defending the litigation. Also, the distraction from core business activities and the strain on internal resources involved in litigation are no different than in the past. For this particular question, at present there is no easy answer.

Does This Decision Decrease the Value of Patent Holdings?

Simplistically stated, patents derive their economic value from the right to exclude others from practicing the disclosed invention. One could view the eBay decision as degrading this right to exclude and therefore conclude it should have an associated negative effect on the value of the U.S. patent stock. Yet, there is nothing in the eBay decision that wholly affects the right to exclude. What it has done is create a relationship between the right to exclude (and arguably the economic value of the patent) and the characteristics of the patent's holder and its commercial embodiments. Because of this, it appears there will be even more pressure for the United States to develop a more liquid intellectual property marketplace to facilitate the efficient transfer of patents to owners who can maximize their economic potential.

Does This Change the Expected Cost of a Patent Litigation?

The knee-jerk response to this question is 'yes.' It would seem that in cases where a permanent injunction seems unlikely, a defendant now facing less potential downside would be more likely to continue the litigation into its later stages. The relationship between the duration of litigation and its expense is no mystery. Some believe that this may be offset by a plaintiff's now-increased desire to settle. Without the threat of an injunction, a settlement negotiation begins to look more like a non-hostile license negotiation. It may now make strategic sense for a patent holder to negotiate earlier in the litigation process while discovery and rulings related to the patent's validity and the breadth of its claims are preliminary and unclear. The deciding factor will be in the adjustments both sides of the litigation make in their value expectations as a result of eBay. The jury is, as they say, still out on this question.

How Does This Affect the Cost/Benefit Analysis in Determining Whether to File an Infringement Suit?

An analysis based on the four-factor test should be performed on a
circumstance-specific basis when contemplating filing an infringement suit. If the suit is perceived as necessary to protect the core business or curb competition, the effects of eBay should generally be minimal as an injunction under such circumstances would be likely. If filing suit solely in an effort to monetize patent rights, the four-factor test analysis should allow an assessment of the likelihood of an injunction. This should, in turn, affect the value expectations that further must be weighed against potential cost. As noted above, with the potential change in litigation costs unclear, the cost/benefit result is still unknown at this time, at least in the case of a suit purely focused on monetization.

Does This Decrease the Strategic Value of Public Disclosure and Patenting Compared with Other Forms of Intellectual Property Protection?

There are many who do not expect to see a shift from public disclosure and patenting to other forms of IP protection. Shifting to a trade secret policy over a patenting policy would only make sense for a commercializer, but these entities are not likely to be affected from a plaintiff-perspective by eBay. Theoretically, because of the effect on economic value of certain patents to certain parties, there may be increased instances of public disclosures without accompanying patents. This would seem most likely from academia or individual inventors, although the Court's opinions suggest that these types of patent holders should be given special consideration when ruling on a motion for permanent injunction.

Does This Impact the Economics of Setting Up an IP Holding Company?

When an IP holding company sues for patent infringement, its parent company may want an injunction so that it (the parent) can continue to exclude a competitor from the market. If only the IP holding company is named as plaintiff, there is now the possibility that the parent may not be granted this request. IP holding companies should theoretically try to maximize their own revenues, but they must also attempt to increase total shareholder value, and the only shareholder is typically the parent company. How the courts treat IP holding companies when the issue of an injunction is on the table will likely have a significant effect on the value of IP holding companies.

Final Thoughts

Clearly, the questions discussed above are only some of the many that arise from the eBay decision. Other questions relating to the impact within companies and questions concerning external IP management will continue to surface. Answers to these and still more questions are likely to be raised in the coming months as the courts provide additional commentary, definition, and clarification on the issue.

The authors are both employees of Ocean Tomo, an Intellectual Property Merchant Banc specializing in the monetization of Intellectual Property assets. Andrew W. Carter is a managing director and chief operating officer. Adam T. Clifford is an associate focusing on the firm's Expert Services practice.

The effect of the Supreme Court's May 2006 opinion in eBay v. MercExchange is already visible in the world of intellectual property litigation. A handful of subsequent district court opinions relating to damages and permanent injunctive relief for patent infringement have been handed down with outcomes substantially outside of what would have normally been expected less than even a year ago, using the eBay decision as precedent. Although the true and long-lasting effect of this decision on litigation remains to be seen, its directional influence is clear. However, what is unclear is the effect that eBay will have on real-world intellectual property management and investment. The appropriate manner in which to react to these recent changes in the litigation realm is currently an area of much discussion by corporate IP departments, patent licensing and enforcement companies (P-LECs) and financiers.

In the unanimous eBay decision, the U.S. Supreme Court held that a plaintiff is not automatically entitled to a permanent injunction simply by proving infringement by the defendant. Prior to this, an automatic injunction was the de facto standard in the district courts, which granted injunctions in all but extraordinary circumstances. Instead, the Court affirmed a four-factor test to assess the appropriateness of a permanent injunction: 1) irreparable injury; 2) inadequacy of remedies at law; 3) balancing of hardships; and 4) the public interest. Because an analysis based on this framework requires some balancing of equities, in practice the decision is usually made by the presiding judge and not the jury. The concurring opinions issued in the eBay opinion address additional issues of importance to the business world. These relate to injunctions and P-LECs, university research, and business method patents.

In z4 Technologies v. Microsoft Corporation, heard before the traditionally pro-plaintiff Eastern District of Texas, the District Court issued an opinion in June 2006 denying z4's motion for a permanent injunction. It found that z4 would not suffer irreparable harm and also referred to the Justice Anthony Kennedy's concurrence that suggested a permanent injunction may be inappropriate in cases where the patented technology only relates to a small portion of the infringing product. In this case, the running royalty the court assigned for Microsoft's future use of the patented invention was equal to the reasonable royalty the jury awarded for past damages, simply applied to future sales. It is notable that the term of this compulsory license was a short one; as part of its argument against a permanent injunction, Microsoft cited the fact that the subject technology had already been designed out of its next generation product, which was due for release within the next year.

The following month, another motion for permanent injunction was denied in another Eastern District of Texas decision, Finisar Corporation v. DirecTV Group. Again, the opinion was based on an analysis of the four-factor test laid out in the eBay decision. Three differences between this opinion and that of z4 are particularly interesting. The first is that the Finisar patent claims did cover fundamental aspects of the infringing product. The second is that the compulsory license created by the court was for the remaining life of the patent. Third, the running royalty rate was decided by the judge, not the jury. The judge considered many factors in determining a fair royalty rate. These factors included the licensing history of the parties and industry practices, the relationship between the parties, the profitability of the parties, as well as expert testimony and the jury's damages award. It disregarded the finding that the defendant had willfully infringed on the patented technology.

Reflection on these opinions leads one to conclude, at least initially, that the eBay decision will in fact reduce the number of permanent injunctions granted by the courts. There are some that go so far as to believe that it may make them all but impossible to obtain by non-practicing/non-commercializing entities. In the absence of an injunction, a compulsory license is the only form of relief for IP owners. At this early stage, it does not appear that these licenses will be a windfall to owners, nor an undue hardship on infringers. However, this is based on only a handful of cases. Instead of providing clarity, many questions relating to the effect on the underlying value of intellectual property and the interrelationships between participants in the IP marketplace have arisen:

Should Companies Fight Longer and Harder Against P-LECs?

From the time of their inception until today, the business model of P-LECs (sometimes referred to as 'patent trolls') has depended largely on stick licensing and the threat of litigation. The eBay decision has, at least for now, appeared to dull the point on the end of that stick. Indeed, Justice Kennedy's concurring opinion specifically noted that permanent injunctions often should not be available to these types of entities. Although the prospect of paying court-awarded past damages and an ongoing future royalty is not pleasant, litigation is considerably less intimidating without the possibility of a business-halting court order, as RIM, the maker of the Blackberry', can surely attest. This is not to say that reaching an early settlement agreement with a threatening P-LEC is not without its advantages. The total amount of past damages and a future royalty can be substantial and difficult if not impossible to accurately forecast, as are the costs associated with defending the litigation. Also, the distraction from core business activities and the strain on internal resources involved in litigation are no different than in the past. For this particular question, at present there is no easy answer.

Does This Decision Decrease the Value of Patent Holdings?

Simplistically stated, patents derive their economic value from the right to exclude others from practicing the disclosed invention. One could view the eBay decision as degrading this right to exclude and therefore conclude it should have an associated negative effect on the value of the U.S. patent stock. Yet, there is nothing in the eBay decision that wholly affects the right to exclude. What it has done is create a relationship between the right to exclude (and arguably the economic value of the patent) and the characteristics of the patent's holder and its commercial embodiments. Because of this, it appears there will be even more pressure for the United States to develop a more liquid intellectual property marketplace to facilitate the efficient transfer of patents to owners who can maximize their economic potential.

Does This Change the Expected Cost of a Patent Litigation?

The knee-jerk response to this question is 'yes.' It would seem that in cases where a permanent injunction seems unlikely, a defendant now facing less potential downside would be more likely to continue the litigation into its later stages. The relationship between the duration of litigation and its expense is no mystery. Some believe that this may be offset by a plaintiff's now-increased desire to settle. Without the threat of an injunction, a settlement negotiation begins to look more like a non-hostile license negotiation. It may now make strategic sense for a patent holder to negotiate earlier in the litigation process while discovery and rulings related to the patent's validity and the breadth of its claims are preliminary and unclear. The deciding factor will be in the adjustments both sides of the litigation make in their value expectations as a result of eBay. The jury is, as they say, still out on this question.

How Does This Affect the Cost/Benefit Analysis in Determining Whether to File an Infringement Suit?

An analysis based on the four-factor test should be performed on a
circumstance-specific basis when contemplating filing an infringement suit. If the suit is perceived as necessary to protect the core business or curb competition, the effects of eBay should generally be minimal as an injunction under such circumstances would be likely. If filing suit solely in an effort to monetize patent rights, the four-factor test analysis should allow an assessment of the likelihood of an injunction. This should, in turn, affect the value expectations that further must be weighed against potential cost. As noted above, with the potential change in litigation costs unclear, the cost/benefit result is still unknown at this time, at least in the case of a suit purely focused on monetization.

Does This Decrease the Strategic Value of Public Disclosure and Patenting Compared with Other Forms of Intellectual Property Protection?

There are many who do not expect to see a shift from public disclosure and patenting to other forms of IP protection. Shifting to a trade secret policy over a patenting policy would only make sense for a commercializer, but these entities are not likely to be affected from a plaintiff-perspective by eBay. Theoretically, because of the effect on economic value of certain patents to certain parties, there may be increased instances of public disclosures without accompanying patents. This would seem most likely from academia or individual inventors, although the Court's opinions suggest that these types of patent holders should be given special consideration when ruling on a motion for permanent injunction.

Does This Impact the Economics of Setting Up an IP Holding Company?

When an IP holding company sues for patent infringement, its parent company may want an injunction so that it (the parent) can continue to exclude a competitor from the market. If only the IP holding company is named as plaintiff, there is now the possibility that the parent may not be granted this request. IP holding companies should theoretically try to maximize their own revenues, but they must also attempt to increase total shareholder value, and the only shareholder is typically the parent company. How the courts treat IP holding companies when the issue of an injunction is on the table will likely have a significant effect on the value of IP holding companies.

Final Thoughts

Clearly, the questions discussed above are only some of the many that arise from the eBay decision. Other questions relating to the impact within companies and questions concerning external IP management will continue to surface. Answers to these and still more questions are likely to be raised in the coming months as the courts provide additional commentary, definition, and clarification on the issue.

The authors are both employees of Ocean Tomo, an Intellectual Property Merchant Banc specializing in the monetization of Intellectual Property assets. Andrew W. Carter is a managing director and chief operating officer. Adam T. Clifford is an associate focusing on the firm's Expert Services practice.