States Revise Laws to Curb 'Patent Trolls'

New Legislation Sets Tougher Rules Around Demand Letters

By Ruth Simon and Angus Loten
May 21, 2014

States are rewriting their laws to make it more difficult for so-called "patent trolls" to
pursue small businesses over questionable patent claims.

At issue are patent claims made by companies that don't produce any goods or services,
but instead purchase patents and then seek profit from them. These firms typically send
so-called demand letters to companies seeking royalties and threatening legal action for
patent infringement.

Roughly half of the companies targeted by these patent claims said they had revenue
under $10 million, or are believed to be that small, estimates RPX Corp., a provider of
risk management solutions. The total number of lawsuits alleging patent claims rose
12.4% to 6,092 in 2013, according to Lex Machina, a legal analytics company.

On Friday, Oklahoma became the 12th state to enact legislation aimed at reining in so-
called "patent trolls," which critics say have saddled small businesses with costly legal
fees and muted job growth. That state's law was sparked by complaints from local banks
hit with patent demands related to software used in their automated teller machines,
said Steven Mullins, general counsel to Oklahoma Gov. Mary Fallin.

Vermont was the first state to pass a patent law. "It was mostly our smaller businesses
and our emerging businesses that are technology-based that we really wanted to
protect," said Rep. Paul Ralston (D., Vt.), who sponsored the law last year prohibiting
"bad faith" assertions of patent claims.

Mr. Ralston drafted his state's patent bill, he said, in response to complaints from
business owners like Jerry Tarrant, co-founder of MyWebGrocer Inc. Over the past four
years, the Winooski, Vt., Internet software company, which serves retail grocery stores
and consumer packaged-goods companies, has received at least five demand letters and
was named in one lawsuit from patent-holding companies. Mr. Tarrant said he has
spent more than $100,000 on legal fees alone to fight the claims.

Some new state laws allow companies to sue so-called "patent trolls" in state courts,
while setting tougher rules around demand letterssuch as a requirement for clear
evidence that a company has infringed on a patent, rather than vague accusations. In all,
patent bills have been introduced or enacted in 26 states, including Alabama, Maryland
and Wisconsin, according to the National Conference of State Legislatures.

Entrepreneurs in states without such measures, including Texas, Florida and Arizona,
say they feel vulnerable.

Lawrence Waugh, co-founder of software development services firm Calavista LP of
Austin, Texas, said he received a letter in April 2013 demanding $20,000 for use of an
email tool on a fax machine that Calavista purchased at OfficeMax about two years
earlier. The letter, from FolNer LLC, a subsidiary of Delaware patent firm MPHJ
Technology Investments LLC, warned Mr. Waugh that, if his company didn't comply, it
could face penalties three times higher than the quoted license fee.

Mr. Waugh said he spent several months nervously waiting to be sued for patent
infringement after deciding to ignore the letter. "There was a lot of heartburn and nail-
biting," he said, though he never received any further notices from FolNer.

In January, the New York state Attorney General reached a settlement with MPHJ,
under which the firm was barred from using deceptive tactics to get businesses to pay
for patent licenses. The company reached a similar settlement with Minnesota. At the
time of the New York settlement, MPHJ said in a statement that it believed its attempts
to enforce its patents, "have conformed with applicable law."

FolNer and MPHJ couldn't be reached for comment.

Meanwhile, proposals to rework federal patent laws to address these issues are stalled in
the Senate Judiciary Committee, which on Wednesday called off a markup of proposed
legislation that had been planned for Thursday. "Unfortunately, there has been no
agreement on how to combat the scourge of patent trolls on our economy without
burdening the companies and universities who rely on the patent system every day to
protect their inventions," Senate Judiciary Committee Chairman Patrick Leahy (D., Vt.)
said in a statement.

"The vast majority of these lawsuits are from bottom-feeders that send out letters to all
sorts of small companies," says James Bessen, a lecturer at Boston University School of
Law, noting that small businesses will often pay a nuisance claim because it is less costly
than hiring a lawyer. Only about 5% of the money paid to firms filing these claims goes
to inventors, he said, based on his analysis.

Such demands cost companies of all sizes $12.8 billion in legal fees, settlements or
judgments, according to RPX, which estimates that firms with less than $1 billion in
revenue pay, on average, $800,000 per lawsuit to resolve the claims.

Forty percent of small firms that received demand letters from patent trolls delayed
hiring, changed their product or business strategy or had other "significant" impacts on
their operations, according to a 2012 study by Colleen Chien, an assistant professor of
law at Santa Clara University who now works in the White House Office of Science and
Technology Policy.

Small firms typically cut back spending on research and development after being hit
with costly patent lawsuits, according to a recent study by Roger Smeets, an assistant
professor of management and global business at Rutgers University. Because costly
litigation can be so damaging, "small firms may be forced into unfavorable settlements,"
he said.

According to a study by Robin Feldman, a law professor at the University of California's
Hastings College of the Law, who surveyed 200 venture-capital firms, 70% of venture
capitalists have portfolio companies that have received patent demand letters. The "vast
majority" of claims came from companies "that license or litigate patents as their core
activity," according to the study, which found that existing patent claims could be "a
major deterrent" to investing in a startup and cost, on average, $100,000 to combat.
The results of the study are expected to be released this year.

The crackdown on certain patent-holding companies is complicated, however, in part
because of a need to protect legitimate patent holders, including many small companies.

Nobody wants to make it more difficult for small businesses and startup companies to
be able to assert their own legitimate rights, said Julie Hopkins, a partner at Tydings &
Rosenberg LLP, which handles patent disputes.

In a rare court victory, FindTheBest.com Inc., a Santa Barbara, Calif., search engine that
lets users compare businesses and products, last year successfully challenged a patent
assertion lawsuit filed against it in New York by Lumen View Technology LLC. The
claim was over how the three-year-old company "electronically stored information,"
according to a letter it received in May 2013 from Lumen's lawyers. The letter offered
FindTheBest a chance to "discuss license terms," which co-founder Kevin O'Connor said
came to roughly $50,000.

FindTheBest, which has raised roughly $17 million in venture capital and has more than
$10 million in revenue, chose to go to court. In November, a Southern District of New
York judge invalidated Lumen's patent.

Mr. O'Connor said the company is now awaiting a decision on who will pay its legal
feeswhich amounts to about $250,000.

Lumen couldn't be reached for comment.