Beware the Tolls of Patent Trolls

By Christopher Demetriades, cdemetriades@feldmangale.com

Patent trolls (officially referred to as “Patent assertion entities”) gather and hold patents to enforce with no intention of putting them into production. As of late, trolls have shown an increased enthusiasm for looking beyond their traditional tech-industry boundaries for profit, frustrating many in the retail industry. The patent trolls are able to target retailers because patent infringement is not restricted solely to the manufacturing of goods. Selling, or even simply offering to sell such goods, can be grounds for a lawsuit. In the complex world of supply chain logistics, retailers unknowingly selling an infringing product can therefore be targets of patent trolls.

Just how prevalent are patent trolls? According to an April report published by the Congressional Research Service, patent trolls collected $29 billion in direct costs from defendants and licensees in 2011, a 400 percent increase over $7 billion in 2005. In a collaborative effort between Google, Blackberry, and Earthlink, the private sector generated its own report on the growth of patent trolls last month as well. The report found patent troll litigation now accounts for 62% of all patent litigation in the United States, with patent trolls filing four times as many cases today as they did in 2005. The report argues that patent trolls have bottlenecked innovation as they increasingly threaten companies with expensive litigation for infringing weak patents that have become both economically and logistically unfeasible to track. According to the April congressional report, the average suit in which $1 million to $25 million is at stake costs $1.6 million through discovery and $2.8 million through trial.

Demand for change is growing. In a letter sent in March to the House Committee on the Judiciary, Retail Industry Leaders Association (RILA) Senior Vice President of Government Affairs, Bill Hughes, stressed the importance of halting the frivolous and costly lawsuits. In the same month, the general counsel of JC Penny testified before the House of Representative’s Courts, Intellectual Property and the Internet Subcommittee on patent troll litigation abuse. The increasing pressure for reform from companies and trade groups across a range of industries is getting Congress’s attention. Two new pieces of legislation were introduced this month, one in the House, one in the Senate, in an effort to diminish the strength of patent trolls.

While legislation winds its way through Congress though, it is important for retailers to consider several options they have to protect themselves from the economic uncertainty of patent infringement lawsuits. These options include, without limitation, purchasing insurance, indemnification obligations which are implied by law into many transactions of goods, and, most significantly, drafting the appropriate protections into the contracts between retailers and their suppliers.

Insurance
Standard insurance policies are usually explicit in their denial of coverage for patent infringement claims. While specific policies covering patent infringement liability may be available for purchase, they are generally prohibitively expensive and in practice may not provide a realistic option for a retailer trying to protect against a patent infringement claim.  

The law provides a limited amount of security
In general, transactions involving the sales of goods in the United States, including such transactions between retailers and their suppliers, are governed by the Uniform Commercial Code (UCC). The UCC itself is merely a set of model rules which do not have any legal effect until adopted by the individual states. With the exception of Louisiana, however, all of the states have adopted some version of the UCC.  

By default, transactions governed by the UCC offer certain warranties for the retailer purchasing goods from a supplier. One of those warranties is the Implied Warranty Against Infringement (IWAI). The IWAI is meant to assure a buyer that the seller has vetted their product for infringement. If the buyer can establish a breach of this warranty, the seller would be liable to the buyer for all of the buyer’s out-of-pocket costs (including attorney’s fees) arising out of an infringement lawsuit.

There are many reasons, however, why the IWAI may not offer sufficient protection. Some of the most noteworthy are:

1. The IWAI can be disclaimed or limited by agreement. For example, if the agreement between the buyer and seller disclaims all warranties or if the agreement indicates that the goods are being sold “AS IS,” then the IWAI will be inapplicable. Complicating this, there are times when under the UCC it is unclear what terms govern a transaction. Where, for example, a purchase order and invoice contain different and inconsistent terms, the question will often arise as to whose terms govern. This is the so-called “Battle of the Forms.”

2. Under the IWAI, the seller is only warranting that the goods are being delivered free of a “rightful claim” of infringement. What constitutes a “rightful” claim of infringement is subject to interpretation by the courts and may vary not only from state to state, but even within a state.  One possible consequence of this is that a buyer who receives a judgment of non-infringement in an underlying third-party lawsuit may have difficulty winning an IWAI action later against the seller. Essentially when you win, you lose.

3. The IWAI is inapplicable when the buyer provides the seller with specifications for the goods and the claim arises out of compliance with those specifications.

4. Finally, there are other complicated notification requirements that a retailer may need to follow to perfect its rights under the UCC. These can be pitfalls for the unwary.

Additionally, a retailer should beware that if the supplier refuses to honor the IWAI, the retailer will find itself having to deal with two separate actions: one action in which the retailer is defending itself against the allegations of patent infringement by a third-party, and a second action in which the retailer is suing the supplier for breach of the IWAI. Finally, retailers should also beware that their transactions with their own customers are also likely governed by the UCC. This means that absent a disclaimer, retailers too are implicitly warranting that the goods they are selling are free of any rightful claim of infringement. With patent trolls growing more aggressive in their attack on end-users, a retailer could potentially find itself embroiled in indemnification issues with its own customers, both large and small.

Contract language
In the face of potentially prohibitive insurance costs and the many uncertainties inherent in relying on the IWAI, it is imperative that a retailer prepare its defense early — before purchasing anything. One of the most efficient ways to accomplish this goal is to get a supplier to agree to your indemnification provision in your contract.   

What you want to make clear in your indemnification provision:
1. An express warranty of non-infringement for the good(s) you are purchasing.
2. The supplier’s agreement to  defend, indemnify and hold you harmless against all claims of infringement, even if ultimately determined not be “rightful.”
3. The express agreement by the supplier to pay your attorney’s fees and costs and your ability to select counsel of your own choice in defending a claim.
4. Finally, if the supplier is international, it is important to  include a forum selection clause which stipulates all litigation will move forward only in the United States, preferably in your home state, and that any and all disputes will be governed by the law of a favorable state.

Conclusion
As patent trolls venture out of their traditional territory, taking on both makers and end-users, they are being met with louder and more organized resistance. New legislation introduced in Congress could potentially weaken trolls by making it easier to invalidate the weak patents they rely on and requiring greater transparency of their practices. Still, the best protection for retailers against patent trolls lies in their contracts with suppliers. By making sure it is indemnified, a retailer will face considerably less uncertainty and greater flexibility when mounting a defense.

Christopher Demetriades is a registered patent attorney with the law firm Feldman Gale. He can be reached at cdemetriades@feldmangale.com.


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