https://flic.kr/p/bYEkm

Most innovations are the result of a cumulative R&D process, i.e., their production requires the combination of knowledge contained in previous innovations (for a general presentation, see my previous ‘Dig It!’ post).

Cumulative innovations raise specific problems that put the patent system under stress. We already explained on this blog that holdup strategies or licensing difficulties may make patents counterproductive.

The patent system may also impose an unnecessary drag on innovation by enabling multiple rights owners to ‘tax’ new products or processes. When multiple firms control essential patents for a new product or process, separate licensing results in higher total prices due to multiple marginalization (or ‘royalty-stacking’). As the transaction costs of contracting with each patent holder also pile up, the total costs of the new product or process necessarily increase.

This situation is sometimes referred to as the tragedy of the anticommons to describe the fact that when several individuals own rights of exclusion and exercise those rights, they restrict the access, and therefore the use, of common resources (see here for some illustrations). As Heller and Eisenberg (1998) explain, this can be seen as the mirror image of the well-known tragedy of the commons (which refers to the fact that a resource – like fishing grounds or clean water – can be overused if it is not protected by property rights).

How serious is this problem? In other words, what is the impact of patent rights on cumulative innovation? This is what Galasso and Schankerman (2013) try to estimate empirically. Before stating their results, it is important to stress that this type of estimation raises three empirical difficulties.

• First, one needs to identify comparable technologies with and without patent protection. The author address this issue by exploiting patent invalidation decisions by the US Court of Appeal for the Federal Circuit (which has exclusive jurisdiction in appellate cases involving patents); their sample comprises 1357 decisions from 1983 to 2008, with about 40% of these decisions having led to a loss of patent protection for the technology.
• The second empirical difficulty is that subsequent innovations are difficult to identify. Here, the authors follow the strategy that is commonly used in the literature: they exploit citations by later patents. A patent can only be granted if it is deemed sufficiently novel with respect to the prior art; patent applicants have thus to describe the prior art and for that matter, they have to cite all relevant patents, even those that have been invalidated.
• The last and major challenge is endogeneity: the factors that make invalidated patents differ from those that are upheld may also affect patent citations; for instance, the commercial potential of a patent may be a common explanation for the facts that this patent led to subsequent innovations and that its owner fought hard to avoid invalidation. To circumvent this problem, the authors exploit a couple of institutional facts: judges are randomly assigned to patent cases, and they form panels of three that decide by majority voting. Because judges differ in their propensity to invalidate patents, the author can use these facts to construct an instrumental variable that addresses the potential endogeneity of invalidation decisions.

It is thus possible to estimate the impacts of patent rights on cumulative innovation by examining how invalidation of a patent affects the rate of subsequent citations to that patent. The main result is that the removal of patent protection leads to about a 50% increase in subsequent citations to the focal patent. This lends credence to the idea that patent rights do impede cumulative innovation.

However, the authors stress the facts that the 50% increase is an average estimate, and that large variations are observed across sectors. Actually, the positive impact of patent invalidation on subsequent innovation is significant (and large) only in sectors with complex technology (namely computers and communications, electronics, and medical instruments). This is not a surprise as these sectors are also those where the patent thicket is particularly dense. The authors also observe variations across firms along the size dimension: it is mainly the invalidation of patents held by large firms that triggers subsequent innovation by small firms.

I would like you to investigate how common anticommons are. More generally, can you find other empirical and/or theoretical arguments regarding the effects that patent rights have on cumulative innovations?

Patents and contracted research

The two mechanisms for securing innovation that immediately come to mind are patents and contracted research. As we have already explained on this blog (e.g., here), the main drawback of patents is that they impose a monopoly deadweight loss. We have also argued here and here that patents can be diverted from their economic rationale and that such abuses may hinder innovation instead of fostering it. A third potential problem, as we explain here, is that the race to obtain a patent may generate a wasteful duplication of research efforts.

Instead of relying on market forces, governments can choose to fund R&D activities, especially basic research, directly. R&D is either conducted in government laboratories and research centers, or is outsourced to universities or private institutions. The main difficulty with contracted research comes from the moral hazard problems that it raises. As Clancy and Moschini (2013, p. 207) writes:

(…) ultimately the research work is the responsibility of scientists and engineers working either individually or as part of teams. Because research work relies on very specialized knowledge and skills that are heterogeneously distributed, and typically unobservable, and because the production of knowledge is inherently risky, asymmetric information distribution and moral hazard are common in this setting.

Innovation inducement prizes

A third way to secure innovation may be to set up innovation inducement prizes, i.e., ex post rewards for innovations meeting certain prerequisites. As described in a 2009 report by McKinsey and Company, this innovation policy measure is one of the oldest:

Prizes have a long history that includes many examples of award-driven change. For centuries, they were a core instrument of sovereigns, royal societies, and private benefactors alike who sought to solve pressing societal problems and idiosyncratic technical challenges. Famous examples (in addition to the Longitude Prize [established in 1714 by the British Parliament to solve the problem of measuring longitude at sea]) include the Food Preservation Prize—one of several prizes established in Revolutionary and Napoleonic France—designed to help supply the army. The winner established the basic method still in use today for canned foods. Similar awards have been sponsored privately, for instance the Orteig Prize for the first nonstop flight between New York and Paris (claimed by Charles Lindbergh). (…) But in the modern era, as patents and grants have continued to mature, prizes became to some extent peripheral instruments for encouraging innovation.

Yet, the same report shows that today, “prizes are booming once again. Both their value and their absolute numbers have risen sharply.” One well-known example is the H-Prize,which was passed in May 2006 by the US House of Representatives with the objective of overcoming technical challenges related to hydrogen. Modelled after the successful X Prize (which spurred the first privately funded suborbital human spaceflight in 2005), the H-prize offers prizes in three categories: (i) technological advancements (four prizes of up to $1 million awarded biennially in the categories of hydrogen production, storage, distribution and utilization); (ii) prototypes (one prize of up to $4 million awarded biennially that forces working hydrogen vehicle prototypes to meet ambitious performance goals); and (iii) transformational technologies (one grand prize consisting of a $10 million cash award). Another recent example is the £10m Longitude Prize 2014, which focuses on antibiotic resistance.

How do innovation inducement prizes compare to patents and contracted research as an incentive mechanism for innovation? A priori, prizes seem to overcome the main limitations of the other two mechanisms: contrary to patents, prizes do not entail any deadweight loss as no exclusive rights are granted and the innovation is therefore immediately in free access; contrary to government-funded research, prizes do not raise any moral hazard issues as the initiative and the decisions remain with the innovator themselves.

Yet, prizes also have difficulties of their own, or they may not be appropriate for every type of research. This is what I would like you to investigate.

Extracted from a betanews post entitled Apple is a patent troll now

Hee-Eun Kim, an associate with Covington & Burling LLP,  where I work as Of Counsel, has prepared a very useful survey of the last developments involving non-practicing entities (NPEs), more widely known as “patent trolls, in Europe. Paul Belleflamme has addressed the trolling problems in several posts: Beware! Privateers patrol thse patent waters, What to think of ‘patent trolls’? The return and (in French) Patent trolls et marché des brevets, but this is a legal update on the situation in Europe.

There have been lots of developments in Europe concerning non-practicing entities (NPEs) after the post “Will ‘Patent trolls’ soon appear on the European market?” that Alain Strowel posted on ipdigit.  Since then, some NPEs have filed patent cases with European courts.  Also, both industry and policymakers are raising their voice about NPEs in Europe, particularly on the prospects of NPEs litigating in Europe’s upcoming unitary patent system.

The question of the status of NPEs in Europe is taking on increasing importance.  Will ‘patent trolls’ soon appear on the European market?  Or have they longlanded on this continent?  To find out, we need more rigorous evidence-gathering.  Hopefully, the European Commission’s study will shed some light at least on NPEs in the semiconductor industry.  But a lot of homework lies ahead.     

What did industry and policymakers say about the prospects of NPEs in Europe?

·       25/02/2014: As you remember from our previous post, on 26 September 2013 a coalition of manufacturing and non-manufacturing companies sent a letter to the Preparatory Committee of the Unified Patent Court (UPC) expressing concern about certain procedural aspects of the UPC.  On 25 February 2014, the coalition sent another letter recommending to the Committee to incorporate “guidance to the judiciary from the outset on the issues of bifurcation and injunctions when validity is raised, including when to issue a stay of an infringement action and when to issue injunctions.”  Without this guidance, the letter points out that “the potential exists for a court to order an injunction prohibiting the importation and sale of goods even though the patent may ultimately be found invalid (emphasis added, as elsewhere in this post).”   

·        21/02/2014: Benoît Battistelli, President of the European Patent Office (EPO) stated on an EPO blog that “… some users, mainly US, expressed their concerns regarding the potential extension to Europe of [these] patent troll phenomena [of the U.S.]  The legal framework defined by the treaty on the UPC, integrating the European legacy, and the on-going implementing and procedural work done by the Preparatory Committee give all reasons to believe that it will not be the case.  This new litigation system will be well balanced and fit for the purpose.”

·       08/01/2014: EU Internal Market Commissioner Michael Barnier responded to the European Parliament that the Commission “fails to see how the recent Union legislation on patents, namely Regulations 1257/2012 and 1260/2012, could increase the activity of so called ‘patent trolls’ in Europe.”

·       09/12/2013: EU Competition Commissioner Joaquín Almunia mentioned in his speech on IP and competition policy that “[f]or a variety of reasons, patent trolls have been less active in Europe than in the U.S.  However, this could change in the future.  (…)We are watching this space very carefully.” 

In Europe, we are also seeing interesting developments in patent and antitrust cases involving NPEs.

·       10/03/2014: Unwired Planet announced that it sued Google, HTC, Huawei and Samsung in London and Düsseldorf alleging infringement of patents related to wireless communications.  Unwired Planet acquired nearly 2,000 patents from Ericsson in January 2013, most of which cover mobile communication technology.  

·       28/02/2014: The Mannheim Regional Court dismissed IPCom’s two lawsuits against Apple and one against HTC concerning standard-essential mobile technology patents.  IPCom had claimed €1.6 billion ($2.2 billion) in damages from Apple.  IPCom is a German-based NPE that acquired Bosch’s wireless patent portfolio in 2007. 

·       24/02/2014: In a standard-essential patent (SEP) dispute filed by Vringo against ZTE, Vringo announced that the Karlsruhe Higher Regional Court denied ZTE’s motion to stay the lower court’s injunction order until the EU Court of Justice concludes on the legality of injunctive relief based on SEPs in Huawei v ZTE.

·       February 2014: The European Commission apparently closed an antitrust case against InterDigital shortly after Huawei withdrew its complaint against the company.  In December 2013, the two settled most of their patent disputes.     

·       09/12/2013: French sovereign patent fund French Brevets announced that it sued LG and HTC in Germany and in the U.S. for infringement of patents related to NFC technology.

The topic of NPEsin Europe is under study, and more such efforts would be welcome!

·       16/01/2014: The European Commission launched a “Study on the changing role of intellectual property in the semiconductor industry – including non- practicing entities,” dealing with changes in IP strategy and patenting practices in the semiconductor industry due to concentration and specialization, the emergence of ‘foundries’ and ‘fabless,’ technological developments in the sector and the appearance of NPEs.  A Dutch consortium of TNO and CWTS is conducting the study.  The Commission expects the result to be released in April 2014.   

·       02/12/2013: Erich Spangenberg, founder of IPNav explained in an interview with Intellectual Asset Management (IAM) why his firm favors the patent litigation system of Germany to that of the U.S.  The benefits which he mentioned include bifurcation, speed, limited discovery and expertise of judges. 

·       26/09/2013: An academic study by Prof. Christian Helmers and others concludes that NPEs are responsible for 11% of all patent suits filed in the U.K. between 2000 and 2010.  This  study notes that “NPEs litigating in the U.K. overwhelmingly assert high-tech patents – even more so, in fact, than their U.S. counterparts – despite higher barriers to software patentability in Europe.  (…) We see evidence that the U.K.’s loser-pays legal regime deters NPEs from filing suit, while at the same time encouraging accused infringers to defend claims filed against them.  U.K. NPE suits are initiated by potential infringers more often than by NPEs; rarely end in settlement;  very rarely end in victory for NPEs;  and, thus, result in an attorney’s fee award to the potential infringer more often than a damages award or settlement payment to the patentee.  Together, these findings (…) may serve to quell concerns that Europe’s forthcoming Unified Patent Court will draw NPEs to Europe.”

This blog will keep monitoring NPE developments in Europe.

By Hee-Eun Kim, Covington & Burling LLP

(This is an updated and slightly modified version of this post, published on April 25, 2012.)

In April 2012, Lucy Koh, a US District Court Judge, tried to force a truce on one of the fiercest fronts of what is now commonly known as the “Smartphone Patent Wars”. She ordered Tim Cook and Choi Gee-Sung, the CEOs of Apple and Samsung, to meet and work out their bitter and prolonged patent disputes. The two firms had indeed spent long months suing and countersuing each other, all over the world, for alleged patent infringements (this infographic nicely summarizes the main episodes of this “battle”).

As most companies in the smartphone industry are fighting similar battles (for a very effective presentation of the existing feuds, see the animated graphic proposed by the Financial Times), the peacemaking process that Lucy Koh initiated may prove crucial for saving the industry from a potential collective suicide.

The legal quagmire that currently plagues the smartphone industry results from a combination of forces that regular readers of this blog should be familiar with by now.

1. Smartphones are the archetypal example of a cumulative innovation. They exhibit indeed the two types of cumulativeness: complementarity and sequentiality.

• Complementarity describes the fact that a second-generation product requires the combination of a number of different first-generation innovations (‘many-to-one’). This is clearly the case for smartphones as they result from the collision between computers and mobile-phones, which are themselves already cumulative in nature.
• Sequentiality refers to the notion that a first-generation innovation leads to the creation of many second-generation innovations (‘one-to-many’). This is also the case for smartphones insofar as all handsets have to incorporate a number of existing standards (for, e.g., wi-fi access, email transfers or video display).

2. The previous technical features raise important-and potentially conflicting-economic issues regarding the allocation of intellectual property rights. On the one hand, complementarity raises the prospect of the ‘tragedy of the anticommons’: the allocation of strong property rights to separate right-holders results in higher prices (‘royalty-stacking’) and higher transaction costs. In this respect, some form of ‘collective’ or ‘shared’ property is more prone to favor interoperability and easy access to interfaces.

Sequentiality, on the other hand, is likely to create hold-up opportunities for first-generation innovators if intellectual property rights are defined too broadly (i.e., if the first-generation innovation confers the patentee rights over subsequent innovations). For an explanation of the hold-up problem, see my post on ‘patent privateers’.

3. The importance of the previous two problems is magnified by the sheer density and size of the ‘patent thicket’ that engulfs the smartphone industry: according to estimates, a smartphone is open to a quarter of a million patent claims. If you factor in the diversity of players (as companies flock from industries as diverse as equipment manufacturing and software development), the crucial need for interoperability (just try to imagine how painful your life would be if several incompatible email services were coexisting), and the high profitability of the whole market (the global mobile phone industry reached a value of US$1.18 trillions in 2011), you easily understand why even though private solutions to the previous problems do exist (patent pools and standard-setting organizations address the tragedy of the anticommons while licensing agreements may solve the hold-up problem), these solutions are very hard to achieve in the smartphone arena.

Accordingly, some players in the market have called upon the competition authorities to sort out the mess. Some observers have been rather critical of the authorities’ abilities to do so. For instance, in an article posted on this blog, Yann Ménière expresses doubts that competition authorities would be able to impose sanctions that address the fundamental problem(s).

What do you think?

1. Was Lucy Koh’s move effective? Did the ‘Smartphone Patent Wars’ calm down over the last months or did they go on with a vengeance? 
2. Could competition law play a useful role in achieving a truce in the smartphone patent war? Or are there any other solutions that could push the industry back to a path where  consumers benefit more of inventions than patent litigators?

Answer one or the other question in your comment. 

Source: www.last.fm

It is under this title that a series of articles (published in the Belgian newspaper La Libre Belgique on October, 19 2013 and prepared by Laurent Lambrecht; see here) wondered if the future unitary patent and unified patent court might attract “trolls” in Europe. “The risk is not negligible“: this is my answer, summarized in the interview available on LaLibre.be (here).

What makes this issue topical is the open letter (26 September 2013) jointly signed by 16 U.S. and European companies, including Adidas, Deutsche Telekom, Apple, Google and Microsoft. This letter criticizes some aspects of the adopted judicial system and suggests some changes to be made to the still to be adopted rules of procedure before the future unified patent jurisdiction.
As a reminder, the term ‘patent trolls’, which refers to small evil creatures from Norse mythology, is used to describe companies that acquire patent portfolios not to exploit them but to negotiate licenses, potentially under the threat of an action for patent infringement  (see the article ‘patent troll’ in Wikipedia). We also speak, more neutrally, of ‘Non-Practicing Entities’ (NPE) for non-operating entities, or “Patent Assertion Entities” (PAE) to identify entities that put their patents into practice through litigation. Such legal actions have proliferated in recent years, as shown in the table hereunder (taken from a White House blog). Some people, like Paul Belleflamme noted in one of his articles on this subject on IPdigIT (What to think of ‘patent’ trolls’?) defend these trolls as they are ahead of other companies in anticipating technological progress. I also refer you to other posts that Paul published on this blog on various aspects of the subject (see here and here).

Many observers disapprove the actions of those entities because they assimilate their business model to judicial ‘blackmail’. But can we talk of blackmail when one does nothing but enforce a legal right that one owns? When is a legal action abusive? Couldn’t it be that the problem is just that the patent shouldn’t have been granted in the first place? Behind the abusive behavior of ‘patent trolls’ would therefore lie the question of the quality of the patents granted by the Patent Offices. These are broad and complex issues indeed. But these issues start to be addressed by public authorities, at least in the United States. To a point that President Obama, in February 2013, spoke harsh words against patent trolls: “They don’t actually produce anything themselves. They’re just trying to essentially leverage and hijack somebody else’s idea and see if they can extort some money out of them” (see also the article in the New York Times: Obama Orders Regulators to Root Out ‘Patent Trolls’).

One of the advisers to the President wrote in June on the blog of the White House (here):

When businesses need to constantly worry about abusive patent litigation they are able to put less of their efforts into creating new products and serving customers. Today, some of the largest innovators in high-tech spend more money on patent litigation and acquisition than they do on research and development for new products. Smaller companies are getting hit just as hard, and 40% of technology startups targeted by patent trolls reported a significant impact on their business operations due the suit or threat thereof. It’s clear that the abuse of the patent system is stifling innovation and putting a drag on our economy. The trolling has gotten out of control, and it’s time to act.

As reported in the Financial Times of October 21, 2013 (U.S. Plans to crack down on patent ‘trolls’, access to the article through online registration), bills to limit these abusive behaviours are on the table of the Congress, just two years after the adoption of the Invent America Act, which amended the U.S. patent law rather significantly. Here are some of the proposed measures to fight patent trolls: increasing transparency regarding the NPEs which file those court actions, strengthening the review process of the patents after they have been granted so as to eliminate “bad patents”, reforming the law of evidence (discovery procedure very cumbersome and costly), etc.

But back to Europe. Why does the risk to see ‘patent trolls’ coming increase with the establishment of the system of unitary patent and unified patent court (official texts here)? The main argument has to do with the increased leverage of the future patent: it will indeed be possible to obtain a legal injunction valid on a large market (at least 13 Member States, including the three largest countries: Germany, France and the United Kingdom). Today, court injunctions in case of patent infringement can, in principle, only be effective for a single country (no cross-border effect). But isn’t it the case that the ‘sword of Damocles’ of an injunction already exists in the current system? Can a company that wants to enter the European market succeed if it does not sell on the German market? In any case, as far as the large companies that signed the letter mentioned above are concerned, one can hardly imagine that they can do without the German market to distribute their products and services in Europe. Hence, it is not that clear that the leverage effect will be seriously raised in the future.

In addition, German patent law already features what is known as ‘bifurcation’ (for an explanation, see here); so, the potential risks of this system (reported in the letter) are already present on the key market for Europe.

There are counter-arguments, pertaining, for instance, to the specificity of the US procedure and to the culture of litigation that is well known in this country. As I recall it in the interview, “In the U.S., 60% of cases are judged by a jury (see the statistics compiled annually by PWC.) We do not know which way a decision can go and this puts the ‘patent trolls’ in a strong position to force companies to settle.” In Europe, only professional judges rule on patent cases, thus limiting somewhat the uncertainties caused by juries.

The damages that are awarded at the end of these proceedings for infringement are also much lower in Europe. This being said, the cost of legal defense can be very high in Europe, a fact which may encourage companies targeted by trolls to directly negotiate a license, rather than to engage into a lengthy and costly procedure. To balance correctly the costs and benefits of an action versus a transaction, we need to add to the direct costs (attorneys’ fees, expert assessments, etc.), the time and energy that corporate lawyers and engineers devote to legal procedures instead of pursuing their usual job within the company.

As can be seen, there are arguments going in opposite directions. Ultimately, what do you think? Does the unified patent package seriously reinforce the risk of ‘patent trolls’ landing in Europe? Do you agree with the position defended by the companies that signed the open letter?

It is widely agreed that one of the main economic roles of IP law is to create exclusive rights: exclusivity allows innovators to appropriate the returns from their invention and it is the prospect of such returns that gives them the incentives to engage in innovative activities in the first place. It is important to stress that IP law also creates transferable rights. From an economic point of view, transferability is as important as exclusivity. Why? Because transferability makes sure that assets are used by the agent with the highest valuation and, thereby, lays the ground for the creation of a market for technology. As Arora and Fosfuri (2000) rightly put it:

“(…) patents can play a key role in facilitating the purchase and sale of technology, or in other words, the development and functioning of a market for technology. A market for technology helps diffuse existing technology more efficiently; it also enables firms to specialize in the generation of new technology. In turn, such specialization is likely to hasten the pace of technological change itself. The reason for focusing on the development and functioning of a market for technology is that it greatly reduces the transaction costs involved in buying and selling technology, implying that innovators have the option of appropriating the rents from their innovation by means of simple contracts, instead of having to exploit the technology in-house.”

The transferability of patents (via sale or, more frequently, via licensing) paves thus the way for vertical separation in high-tech industries, with ‘upstream’ firms or institutions specializing in the production of new knowledge and ‘downstream’ firms buying and applying this knowledge. This business model seems to spread in the pharmaceutical industry, where big firms tend to move away from in-house development of new drugs and favor instead in-licensing from biotech startups and university researchers (see, e.g., here).

Source: www.institute-for-competitive-intelligence.com

Such ‘division of labor’ based on licensing agreements is likely to have a number of positive economic effects, as explained by Pluvia-Zuniga and Guellec (2009): (a) increase in the diffusion of technology; (b) reduction of wasteful duplicative inventions (no need to reinvent what is on the shelves of someone else); (c) increase in downstream competition (lower barriers to entry related to R&D); (d) improved allocation of resources in the economy; (e) extension of product markets (across industries, larger geographical areas).

However, for patents to be exchanged, they must be offered for sale and they must have potential buyers. The previous statement sounds like a tautology but, when it comes to technology, buyers and sellers usually have a hard time to find each other. Moreover, when they do find each other, the large costs of negotiating and writing licensing contracts may make the trade of IP unprofitable. Finally, as argued by Troy and Werle (2008), various sources of uncertainty plague the functioning of markets for technology:

“(…) uncertainty is related to the novelty of knowledge on the one hand and to its goods characteristics on the other.”

Public intervention may thus be called for in order to improve the functioning of markets for technology. I would like you to think about potential interventions and, if possible, to find examples of interventions that public authorities have already implemented (in the EU, in the US or elsewhere).

(This is an updated version of a previous post, first published in 2010.) 

Because of the on-going developments, Paul Nihoul, Professor at the UCLouvain, and myself have decided to organise a conference on this topic. The conference was held on October 18, 2013 in Brussels. You can find the programme here. Before adding a short report on the conference (see below with the presentations used by the speakers), let me summarize the issue and refer to the recent legal developments.

The patent settlements under scrutiny by several competition authorities involve a payment from the originator pharmaceutical company, holder of a patent, to a generic company.  Those settlements also include other clauses (such as ‘non-compete clauses’) which have the effect of delaying the entry of the generic product on the market. Those patent settlements are designated as “pay-for-delay” deals or reverse payment settlements. Do they have an anti-competitive effect? Their assessment requires an economic analysis, but it is not that easy to assess the overall cost and benefit of those agreements, including their impact in terms of consumer welfare, as already noticed by Paul Belleflamme on this blog (see ‘Pay for delay’ deals in the pharmaceutical industry, including the May 2013 presentation of Matthew Bennett, Charles River Associates, referred to in Paul’s post).

State of the debate in the EU. On June 19, 2013, the European Commission imposed a fine of € 93,8 million on Danish pharmaceutical company Lundbeck and fines totalling € 52,2 million on several producers of generic medicines (see the Commission’s press release) because of their anti-competitive agreement to delay the entry of a cheaper generic version of Lundbeck’s blockbuster antidepressant (citalopram). In September 2013, Lundbeck filed an appeal against the Commission’s decision. The General Court will thus rule on the legality of this patent settlement. DG Competition has already started to review patent settlements in the framework of the pharmaceutical sector inquiry which concluded on 8 July 2009 (see the Commission Communication and the final report). Since then, the Commission engaged in the monitoring of patent settlements and published three reports (the last one of July 25, 2012 is available here). The 2012 report shows that most patent settlements are not problematic. Yet, 11% of the reviewed settlements raise competition issue. In 2012 and 2013, the Commission issued statements of objections in the context of two other investigations involving the innovative companies Servier (see press release) and Johnson & Johnson (see press release). The generic companies having concluded those settlements include Lupin, Mylan, Novartis and Teva.

The rule of reason in the U.S. In the U.S., the Federal Trade Commission (FTC) has challenged the pay-for-delay deals for several years. The issue of whether they violate the competition rules (including the Sherman Act)  has been tried by six U.S. courts of appeals, resulting in a circuit split. For some circuit courts, a correct treatment of a pay-for-delay settlement requires an analysis of the scope of the exclusionary potential of the patent and a determination of whether the scope of the settlement exceeds the scope of the patent. At least one court of appeal disagreed with this test and found that a reverse payment must prima facie be considered as anti-competitive. On June 17, 2013, the U.S. Supreme Court issued its Actavis decision which concluded that lower courts should not automatically dismiss the FTC’s complaints. Rejecting a general rule of legality based on the “scope of patent” test, the U.S. Supreme Court held that a “rule of reason” should apply to pay-for-delay deals. Thus, the effects of those settlements must be assessed using “traditional antitrust factors” including “likely anti-competitive effects, redeeming virtues, market power, and potentially offsetting legal considerations present in the circumstances, such as those related to patents” (FTC v. Actavis, Inc. 133 S. Ct. 2223 (2013) at 2231).

Patent laws and other rules indeed have an impact on the competition analysis. In the U.S. and in Europe, once a patent is issued, it is presumed valid. The burden for establishing invalidity is for the party challenging the patent. Also, implied in the patent is a right to settle patent litigation. Besides, broader public policy favors litigation settlements.

The debate on the effects of reverse payment settlements also depends on other rules. In the U.S., the Hatch-Waxman Act provides for an extra 180-day exclusivity in favor of the first generic company settling with the patent holder.

The approach in Korea. In Korea, the Competition Authority (Korean Fair Trade Commission or KFTC) decided it first reverse payment case in October 2011. The case involves a patent settlement concluded between GlaxoSmithKline (GSK) and Dong-A, a leading Korean pharmaceutical company. The KFTC found the agreement contrary to Article 19 of the Monopoly Regulation and Fair Trade Act (an equivalent to Art. 101 TFEU) and fined GSK approximately € 2 million and Dong-A € 1.5 million. As there is no US-style exclusivity in favor of the first generic company, the settlement did not restrict other generics from entering the market after GSK’s patent expiry. However, the KFTC considered that the scope of the settlement exceeded the patent scope because the restriction to entry also applied beyond the patent term and the settlement included a deal on another product unrelated to the patent dispute. On October 11, 2012, the Seoul High Court’s 7th Administrative Division affirmed the fine imposed on GSK. GSK subsequently filed an appeal with the Korean Supreme Court.

What are the interests involved ? The competition analysis must take into account the interests of the consumers. Obviously, consumers will directly benefit from lower prices of drugs. As long as patent settlements help to maintain higher prices, the consumers’ interest might be hurt – the health expenditures and the tax-paying public will be affected too.  However, one has also to take into account the long-term interest of consumers to benefit from the availability of new medicines (see my post “Challenging pharmaceutical patents: a ‘death spiral’ for generic companies?“). A balanced competition policy must facilitate the entry of lower-priced drugs, but must also keep the incentives for innovative companies to develop new products. How to strike the right balance? Competition authorities tend to be too much focused on the existing markets, showing sometimes a form of short-termism.

On the other hand, patent experts tend to overstate the forward-looking incentive effect of patents without clearly demonstrating how longer exclusivity really results in increased investments and the development of innovative products. There has always been a strong pressure to extend the scope of the legal exclusivity (either by law or court decisions), what might be called the “increasing propertization” of intellectual property. Both pitfalls (short-termism and propertization) must be avoided to obtain the right mix of a vibrant competition policy and a innovation-geared patent policy.

What could be the solution? Do we need legislation? In the U.S., several bills showing bipartisan support are on the table of Congress. The Preserve Access to Affordable Generics Act presumes that pay-for-delay deals are anti-competitive and unlawful. It would thus be for the parties to the settlement to prove that its benefit ouweighs the presumed harm. Is this shift of the burden of proof reasonable and sustainable? Such an outcome might come close to what the Commission’s DG Competition has decided in Lundbeck when presuming that pay-for-delay settlements are anti-competitive “by object”. As noted by commentators, “this anti-competitive presumption is precisely what the FTC had wanted in Actavis, but the Supreme Court ultimately rejected” (B. Batchelor and F. Carlin, Turducken on the Menu: Initial Refections on the Implications of the European Commission’s Lundbeck Decision, European Competition Law Review, 2013, 455). Another U.S. bill (the FAIR Generics Act) aims to solve the problem by letting a second generic drug company enter the market if the first generic company takes a pay-for-delay deal. This might have even wider implications for the exclusivity granted to the patentee.

Short report on the USL-UCL conference on patent settlements (Brussels, 18 Oct. 2013). Reverse payment settlements thus raise many issues. Those questions were debated at the conference held on October 18, 2013.

For the names of the speakers and the detailed program, look at Patent Settlements).

For a brief presentation of the topic of the conference and of the program, consult Strowel.Intro.

The conference included three panels: the first panel (the Professors’ panel) offered an overview on the legal developments in the U.S. (see the presentation of Prof. John Kallaugher, Visiting Prof. at University College, London and partner with Latham & Watkins at Kallaugher US), in the EU (see the presentation of Prof. Josef Drexl of the Max-Planck Institute, Munich:Drexl. EU) and in South Korea (see the presentation of Prof. Hwang Lee of the Korea University School of Law, Seoul: Lee Korea).

During the second panel, the various stakeholders could present their view: first, the innovators with Ms Kristine Peers (Pfizer speaking in the name of the European Federation of Pharmaceutical Industries and Associations: Peers.EFPIA); second, the generics with Ms Ingrid Vandenborre (Partner with Skadden speaking in the name of the European Generics medicines Association: Vandenborre.EGA), then, the consumers with Ms Ilaria Passarani (BEUC, the European Consumers Organisation: Passarani.BEUC).

The third panel allowed several additional voices to be heard: first, the competition practitionner David Hull (Partner with Van Bael & Bellis), second, the economist Benoît Durand (Partner with RBB Economics), then the patent expert Esther Van Zimmeren (Prof. University of Antwerpen). This allowed for a lively discussion as you will be able to hear from the video to be added here.

The discussion will continue in the coming months. We hope more guidance will be offered by the General Court which will rule in the Lundbeck issue.

One difficult question that resulted from the discussion we held is how to distinguish cases involving true patent settlements and those which are just disguised cartels (Indeed, as there are so many patents around many (pharma) products, clever lawyers could be tempted to design a commercial agreement (that is in reality a cartel) as a fake patent settlement agreement). The level of payment by the originator to the generic company might well be a decisive factor to separate cartel cases from cases where a patent settlement is really involved.

Let’s wait for the future developments in this interesting area at the interface between IP and competition law, between legal and policy issues, between IP/Competition law and (pharmaceutical) regulation.

Because they blossom in winter and display striking red and green colors, poinsettias are ideal for Christmas decorating. Yet, their market domination did not happen by chance. It resulted from more than a century of clever decision-making by the Ecke family in California. The story of the Ecke poinsettias provides a nice illustration of two major choices that many innovative firms face one day or another:

• What is the most effective way to protect an innovation: secrecy or patent?
• Which market(s) should an innovative firm operate in: the market for ideas and/or the market for products?

Regarding the first question, part of the Ecke’s success is due to a technique for grafting together two varieties of poinsettias that was kept secret for decades. It is only when this technique was discovered that competitors were able to enter the market. Yet altogether, secrecy allowed the Ecke family to protect their innovation for a longer period than if they had been granted a patent.

The discovery of the Ecke’s secret brings us to the second question. As competitive pressure increased on the product market, the Ecke family decided to focus increasingly on the markets for ideas: they sold off more than half of their land, invested heavily into new research facilities, and started to patent new varieties.

We have already addressed the latter choice (marketing ideas or products?) twice on this blog:  we described here a theoretical framework to guide this choice, and we illustrated it here with a number of real-life examples.

Regarding the choice between secrecy and patents, we have only provided a theoretical analysis so far (see here). The objective of this post is to complement the theory with some practical guidance as to how innovators should choose between the two modes of protection. To this end, we present here the roadmap proposed by Daizadeh et al. (2002). It must first be noted that the authors consider a third option on top of secrecy and patenting:

[T]echnologists, especially scientists, may consider a more defensive strategy—publishing inventions in technical or trade journals. (…) A defensive publication establishes prior art against competitors—potentially disabling a patent or preventing a patent from issuing and thereby canceling a competitor’s claim on a piece of intellectual property.

To guide the choice between the three strategies, the authors develop a 6-step approach, which we sketch here:

• STEP 1. Is public disclosure necessary? Yes? –> Patent
• STEP 2. Is the idea easy to reverse engineer or discover independently? Yes? –> Patent
• STEP 3. Is the technology area evolving quickly? Yes? –> Secret
• STEP 4. Is it a new area of technology? Yes? –> Patent
• STEP 5. Are you potentially interested in licensing the invention? Yes? –> Patent
• STEP 6. Do the potential market revenues outweigh the patent and associated costs? Yes? –> Publish

The roadmap is better described in the following graph.

Source: http://www.nature.com/nbt/journal/v20/n10/fig_tab/nbt1002-1053_F1.html

Jorda (2007) proposes another roadmap, made of a list of 11 questions that innovators could find helpful to answer when facing the choice between secrecy and patenting.

Your job is to compare the two proposed roadmaps to see to which extent they overlap, they contradict or they complement each other.

In our latest working paper, Francis Bloch and myself analyze the optimal protection strategy for an innovator of a complex innovation who faces the risk of imitation by a competitor.

Complex innovations

A “complex innovation” is an innovation that can be fragmented into a set of sub-innovations. Although the possibility exists to patent each sub-innovation, innovators may decide to keep some or all of them secret. Such patent-secret mix is common in the food industry where recipes, lists of ingredients or formula are kept secret, while cooking, manufacturing or packaging processes are patented. Here are some well-known examples:

• Kentucky Fried Chicken holds secret the recipe of 11 herbs and spices that go into its fried chicken, and owns, e.g., a patent on “Device and method for frying and grilling”;
• McDonald keeps secret the Big Mac special sauce, and has patented “Method and apparatus for making a sandwich” and “Device and method for cooking food on a grill”;
• Coca-Cola’s syrup formula is a trade secret, but the company also owns patents on “Coffee cola beverage composition” and on “Beverage preservatives”;
• The overall formula to obtain the Ferrero’s Nutella paste is kept secret but packages for food or devices responsible for creating specific food are patented; e.g., Ferrero holds patents on “A container with several compartments” and “Improved solid honey composition and process of manufacture”.

Combinations of patents and trade secrets are also documented in other industries. For instance, Perng Pan and Mion (2010) describe the strategy of Coskata, a producer of biofuel, that “has several pending patent applications on the bioreactor segment of the process”, while “[t]he identity of the micro-organism fed into the bioreactor is protected by trade secret”. The authors further explain that “this does not rule out the possibility of a patent on the biological component”.

Protection strategies

As illustrated by the previous examples, inventors of complex innovations face a rich set of strategies when it comes to protect their intellectual property. They may indeed choose between patenting and secrecy for each fragment of their innovation, which theoretically opens up a large number of combinations. However, the patent regime that is in force may restrict these possibilities.

1. A first requirement for patentability is that the invention be of practical use. A strict enforcement of this utility requirement could prohibit the patenting of fragments of innovations. As a result, the innovator would be left with a binary decision: seek patent protection for the entire innovation or for nothing.
2. A second requirement is that the invention show an element of novelty; that is, it must show some new characteristic that is not known in what is called the “prior art”, i.e., the body of existing knowledge in the technical field of the claimed invention. Hence, a strict interpretation of the novelty requirement could prevent inventors from patenting long held trade secrets.

In our paper, we provide a unified model to study the protection of complex innovations. The model allows us to analyze the innovator’s choice of patent/secret mix under various patent regimes, which differ according to the strength of the utility and the novelty requirements.  Our main result is to find conditions under which the innovator optimally chooses to mix patents and secrets (in a static framework corresponding to a strict novelty requirement), or to patent sequentially two fragments of the innovation (in a dynamic framework corresponding to a softer novelty requirement). It is important to stress that a pre-condition for these results to apply is that the innovator’s profit function be concave in the fraction of the innovation that the imitator can exploit. This occurs when the imitator must learn a large fragment of the innovation in order to be able to exploit it usefully. In contrast, if convexity prevails, the innovator will optimally choose an all-or-nothing strategy that consists in patenting the whole innovation or in keeping it altogether secret.

The AIA reform

Noteworthy is the fact that the American Invents Act (AIA, passed in 2011) has considerably softened the novelty requirement. Besides the well-known conversion of the U.S. patent system from a “first to invent” system to a “first inventor to file” system, the AIA also eliminates several types of secret prior art. As Maier (2011) explains, this change (which became effective in March 2013) implies that long held trade secrets are now patentable:

the forfeiture that previously penalized inventors for maintaining their inventions as trade secrets for some period of time longer than a year is no longer applicable, and inventors are left with the option to practice their invention as trade secrets for now and still patent those same inventions later (assuming, of course, that no other inventor files a patent application claiming the same subject matter first).

According to our analysis, this change may have positive welfare effects. We indeed find examples where the stakeholders (namely the innovator, a potential imitator and the consumers) are all better off in the most flexible patent regime,i.e., when the innovator is allowed to choose not only to patent initially any fraction of the innovation, but also to patent at a later date any fraction of the innovation that was initially kept secret.

This theoretical result may contribute to the debate that is now under way (see, e.g., here, here and here). I would like to hear your views about this debated issue.

Patents are vitally important to protecting intellectual property. Plenty of creativity occurs within the technology industry, and without patents, executives say they could never justify spending fortunes on new products. And academics say that some aspects of the patent system, like protections for pharmaceuticals, often function smoothly.

However, many people argue that the nation’s patent rules, intended for a mechanical world, are inadequate in today’s digital marketplace. Unlike patents for new drug formulas, patents on software often effectively grant ownership of concepts, rather than tangible creations. Today, the patent office routinely approves patents that describe vague algorithms or business methods, like a software system for calculating online prices, without patent examiners demanding specifics about how those calculations occur or how the software operates.

As a result, some patents are so broad that they allow patent holders to claim sweeping ownership of seemingly unrelated products built by others. Often, companies are sued for violating patents they never knew existed or never dreamed might apply to their creations, at a cost shouldered by consumers in the form of higher prices and fewer choices.

US vs. EU

The extent to which software should be patented has been – and still is – a topic of intense debate. Nowadays, there is no harmonization across countries on this matter. As indicated in the quote above, the US Patent and Trademark Office broadly grants patents that may be referred to as software patents (and it has been doing so since at least the early 1970s). In contrast, the European Patent Office has adopted a more restrictive approach (see here):

The truth of the matter is this: Inventions that use computer programs to provide a business process – not a technical process – are not patentable.

A patent application for an Internet auction system was not granted because the system used conventional computer technology and computer networks – which meant it made no inventive technical contribution to the level of existing technology. Such a system may provide business advancement to its users, but that is not the type of advancement required by the EPO.

On the flip side, the problem of improving signal strengths between mobile phones is a technical problem, even if it is solved by modifications to the phone software rather than its hardware. Such an invention would obtain a patent, provided that the solution is also novel and inventive.

In this respect, the granting practice of the EPO differs significantly from that of the United States Patent and Trademark Office (USPTO), where patent protection for software is granted, even if it does not solve a technical problem.

Adjusting patent subject matter, length, and/or breadth?

The contrasting approaches of the USPTO and the EPO are in terms of “patentability” (or patent-eligible subject matter): what are the conditions for a software (or a “computer-implemented invention” in the European terminology) to be patentable? Two other, and potentially complementary, ways to tackle the issue would be to discuss the “patent length” and the “patent breadth” for software.

In terms of length, some scholars, among them Richard Posner (Federal appeals court judge and professor at at the University of Chicago Law School), recommend a shorter patent term for digital technologies. How long should software patents last? Although Posner does not propose an explicit length, others do. For instance, according to the Electronic Frontier Foundation,

A patent covering software should survive for a term of five years, beginning from the date the application is filed.

Other scholars suggest to reconsider the breadth of software patents. For instance, Mark Lemley suggests to limit software patents to their specific way of accomplishing a function. In his paper “Software Patents and the Return of Functional Claiming“, he claims that the real problem with software patents (in the US) is the following:

Software patent lawyers are increasingly writing patent claims in broad functional terms. Put another way, patentees claim to own not a particular machine, or even a particular series of steps for achieving a goal, but the goal itself. The resulting overbroad patents overlap and create patent thickets.

As summarized by Eric Goldman in a Forbes article:

Prof. Lemley argued that many software patents use “functional claiming,” which is patenting a software function (basically, the problem that needs to be solved) rather than a specific way to implement that function (the innovator’s solution to the problem).  For example, currently we allow patent claims in the form “a computer programmed to achieve this result” or “a computer programmable/capable of achieve a result” (his research identified 11,000 patents using the “capable of” language).  Prof. Lemley argued that we should prevent functional claiming in software, allowing patents only on methods of achieving the function, not the function itself.

And you? What do you think? If you had to weigh the pros and cons of software patents, what patent duration and breadth (if any) would you recommend? To help you organize your thoughts, you can use the framework proposed by William Nordhaus in his book “Innovation, Growth, and Welfare” published in 1969  (see Belleflamme and Peitz, 2010, pp. 517-521 for a textbook presentation).

(This is an edited version of a post that I published on this blog in October 2012.)