A Venture Capitalist’s Second Thoughts on Patent Reform

by Scott SandellJun 01, 2015

Note: this post was originally published as an opinon piece in The Wall Street Journal on May 31, 2015

The patent-reform legislation currently being considered by Congress is touted as a crackdown on “patent trolls,” but it would inflict unintended damage on our innovation economy by making it more difficult for small companies to enforce their property rights against infringers.

The term “patent troll,” as I understand it, refers to a company that purchases flimsy patents and uses them abusively to extort unfair payments from legitimate businesses. Although H.R. 9 and S.1137 purport to address such tactics, in reality these bills would raise the cost and risk of patent litigation for all companies, including small ones that can least afford armies of trial lawyers.

The bills would thereby create a litigation shield for the large, entrenched corporations that have promoted the legislative text as a way to protect themselves from disruptive innovation. The list of proponents is long and includes many technology companies—household names like Intel, Google, Ciscoand EMC2—that once were startups themselves but that now seem determined to block those that would follow.

The unparalleled success of American startups is one of our economy’s greatest competitive advantages, and my position affords me a clear understanding of how government policies affect the flow of capital across industries and geographical borders. As co-head of NEA, a venture-capital firm with some $10 billion invested in a broad range of sectors—including software and biotech, where intellectual property is vital—I admittedly have horses in this race. Like many other venture capitalists, I was initially in favor of the patent reform legislation because I was told it would address the abusive litigation that is a nuisance to our companies. Then we read the bills, which go far beyond that objective.

Both bills include provisions that would increase the likelihood that a losing party will be forced to pay the legal fees for both sides (typically millions to tens of millions of dollars). These clauses are overly broad and will affect too many litigants who argue in good faith but lose in court anyway.

Congress must be particularly careful in writing such standards, because precedent in two 2014 Supreme Court decisions, Octane Fitness v. ICON Health & Fitness andHighmark v. Allcare Health Management Systems, already allows courts to award legal fees in “exceptional” patent cases when the loser has engaged in abusive practices or made frivolous arguments. Any new provision that is not strictly targeted will only pull in more legitimate litigants.

The bills would also dictate procedural requirements for patent cases that would impose cumbersome and expensive one-size-fits-all rules on district courts, leaving little room for judges to make specific determinations as to how a case should proceed. A patent owner would be required at the beginning of the litigation to spell out in great detail every instance of infringement that it might want to include in a trial years down the road. Requiring a small company or a startup to go through that exercise at the start of a case is a huge burden.

Another provision of H.R. 9 would mandate a stay of any discovery until after the trial court has conducted abstract hearings to interpret the terms in the patent. These types of rules will increase the cost to plaintiffs by multiples and will delay resolution of patent cases by months or even years.

An even more worrisome feature of H.R. 9: If a plaintiff bringing a patent case loses and then the company goes out of business, the court could stick its shareholders with paying the prevailing defendant’s legal fees. Under this provision, the plaintiff would be required at the outset to identify parties with the financial wherewithal to essentially backstop the litigation expenses. This undermines the fundamental premise of bankruptcy in the American legal system, which has encouraged investment for 150 years.

The nature of venture capital requires a significant appetite for risk, but we take these risks knowing that even in the worst case our losses are limited to the money we invest. We can only lose the capital we put in, no more. Increasing the potential downside of investing would fundamentally change the equation.

A patent is only as effective as the ability to enforce it, and these bills will make it prohibitively expensive for many small businesses to protect their technology against infringement from larger incumbents, who can absorb these expenses as the cost of doing business. Those of us who back startups view enforceable patents as a fundamental requirement for many investments. Consequently, we will be less inclined to support many worthwhile innovations that require intellectual-property protection to succeed in the market.

I believe that it is possible to curb abusive practices without damaging our entrepreneurial ecosystem. Given the importance of innovation to our nation’s economy, and the importance of patents to protecting innovators and the companies they start, I urge our legislators to take the time to get this one right.

Mr. Sandell is managing general partner of the venture-capital firm NEA.