Canada: Watch Out: NPEs Are Coming To Canada!

NPEs, otherwise known as non-practicing entities, or pejoratively referred to by some as "patent trolls", have seen a significant negative impact on their business model south of the border. NPEs are analogous to private equity businesses–their business model is to acquire undervalued patent assets and turn around and sell or license them to others, which often leads to expensive patent litigation. If their assets are depreciating in value, the model becomes significantly less attractive. This is exactly what is happening in the US.

Recent US Supreme Court decisions including Alice, which restricted the scope of patent-eligible subject matter, and eBay, which limited the ability of NPEs to obtain injunctions, along with the post-grant review processes introduced under the America Invents Act, have significantly depreciated the value of some US patent portfolios held by trolls. On average, there have been about eleven Section 101 decisions per month in the US federal courts post-Alice, with the overall rate of patent invalidation in the low 70% range.

Not many people will feel sympathy for the potential demise of the NPE business model in the US. However, they should be concerned about the broader implications of a weakened patent system for American innovation and entrepreneurship. In addition, innovative Canadian companies should be worried about the implications of NPEs shifting their focus north of the border, where litigations costs are a fraction of those in the US, where there is no analogous post-grant review process and where we have yet to see a judicial impediment against trolls obtaining permanent injunctions.

Canada can best avoid the problems experienced in the US from the assertion of patents of questionable inventive value, not by weakening the patent system, but rather by strengthening it. A better pre-grant review process, with highly-trained legal experts in the patent office, will increase the quality of issued patents in Canada. A stronger patent system will attract significantly greater innovation investment in the country and reward innovative businesses.

At a recent conference, NPE 2016 – The Business of Responsible Licensing, some representatives from NPEs indicated that the recent hit to their bottom lines in the US is causing them to turn to other markets. An entire panel discussion was devoted to shifting focus outside of the United States. One executive from a major NPE player said that the spotlight is now on Canada, Germany, and China. Key factors making Canada an attractive jurisdiction are the availability of injunctive relief and the relatively broad legislative definition of patent-eligible subject matter. The lower cost of litigation and the lack of jury trials are also considered to be helpful to plaintiffs. Furthermore, the absence of a post-grant review processes in Canada is a positive for NPEs. One CEO confirmed that his NPE company is increasing activity in the Canadian market, particularly in the technology space. Our patent litigators have already observed an apparent increase in NPE activity in Canada.

Unlike Canada, the NPE business model in the US has become high risk with low finality. In some technology areas, an issued patent is considered to be no more valuable than a pending patent application because of the increased availability of post-grant attacks. As a practical matter, NPEs presume a US patent to be invalid until it has survived inter partes review (IPR). The fight to secure royalty payments has become a never-ending struggle as "efficient infringement" is developing into a favourite sport among potential licensees. This dynamic has decreased the ability to obtain sufficient capital to fund the necessary litigation costs to "out-fight the licensees". In the past, NPEs only needed to go to court to compel an infringer to pay a license fee 1 out of 5 times. Now, NPEs need to go to court on a much greater frequency.

The landscape for buying US patent portfolios is also significantly changing. The participants in the conference generally agreed that NPEs now avoid paying up-front money and postpone payment for US patent portfolios until the patents have withstood IPR challenge. Most of the participants strive to maintain pending continuations on their base specifications so that claims can continue to be revised in the wake of post-grant reviews. In some cases, they pay nothing for the patent and share in the upside 50:50, but in other cases they occasionally pay some "seed money" if the invention seems particularly valuable. Many Fortune 100 companies are divesting their underutilized patent portfolios on a no-money-down, revenue-sharing basis, because they want to get these depreciating assets off the books.

Some of the conference participants anticipate that there will be continued reluctance on the part of potential patent licensees to pay a royalty fee until there is an actual negative impact. One of the speakers expressed hope that the US Supreme Court rulings in Halo and Stryker will lower the bar on willful infringement, thereby raising the spectre of up to treble damages as a deterrent to "efficient infringement". Other speakers believe that judicial history of infrequent enhanced damages awards will still govern despite the decision. Of course, a patent must first survive in order to move this far in the litigation process, so most participants were skeptical that the decision will have a significant impact.

The panel participants were asked whether the pendulum will swing back and US technology patents will become valuable again. Most participants said they do not expect the pendulum to swing back in the next 5-7 years, and some suggested the pendulum no longer exists.

Notwithstanding the seismic shift in the economics of patents, some of the NPEs said that they are still making money. It just means they need to amass larger portfolios of patents to obtain the same licensing revenue stream. Industry consolidation is anticipated as the scale of patent holdings and ability to fund litigation can only be successfully executed by larger NPE players.

It seems surprising that, as the land of entrepreneurship and innovation, the US would allow its patent system to be devalued so significantly. Certainly, some of the invalidated patents were not meritorious, but many valuable inventions are being arbitrarily deprived of protection as well. The American public does not seem to be overly concerned about this development—it is certainly not on the radar of the presidential candidates to any significant extent. This may also help explain why China is now dwarfing the US and Japan in terms of patent filings.

In addition to raising concerns for the future of the US innovation economy, this trend has consequences for Canada with the potential for NPEs to move north. We should learn a lesson from the US that weakening patent protection is the wrong solution; increasing patent quality through a stronger Canadian patent system is the better approach. In Canada, through skillful drafting and advocacy, we have been able to help companies receive the benefit of the more favourable Canadian patent system to obtain computer-implemented invention patents for their valuable inventions in Canada. We help our clients take a strategic portfolio approach, utilizing offensive and defensive commercial, patent prosecution, licensing and litigation tactics, to better protect themselves from third party patent infringement while gaining competitive advantage in the marketplace.

The weakening US patent regime provides a cautionary tale for Canada and presents an opportunity to strengthen the Canadian patent system to attract innovation dollars northward. In the meantime, companies should be reviewing their defensive and offensive intellectual property strategies to prepare for the potential arrival of infringement claims by NPEs in Canada. This should include developing a plan for litigation readiness in key business areas where IP threats have been identified, as well as a litigation review of key patent filings. This is also something we help our clients with regularly.

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