FORTUNE — The U.S. Supreme Court will hear arguments this morning in two cases with the potential to reshape the legal landscape in so-called patent trolling cases. They relate to when a federal judge can order a plaintiff to pay the defendant’s attorney’s fees as punishment for having brought a frivolous suit.
Though not directly involved in either case, Fortune 500 companies ranging from tech giant Apple (AAPL) to consumer goods powerhouse Procter & Gamble (PG) are interested enough in the outcome that they have submitted briefs.
Many critics of patent trolls—companies that do not make or sell products of their own, but exist solely to acquire patents and demand licensing fees from companies that do—hope the Court will relax the extremely high bar that must currently be cleared before a judge can order such “fee-shifting” awards. The current standard is more difficult to satisfy than the one that exists for frivolous copyright or trademark cases, for instance.
“The fee award cases are among the most significant intellectual property cases the Supreme Court will hear this term . . . because of their potential impact on patent trolling,” says professor Robin Feldman, the director of the University of California Hastings Institute for Innovation Law, in an email. “With virtual impunity, more and more entities are spinning questionable patents—or patents aimed at inappropriate targets—into golden income streams and competitive advantages.”
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Defenders of the status quo, on the other hand, argue that relaxing the standard will harm independent inventors and, therefore, society. “Troll” is a pejorative term for companies that are known, more neutrally, as “non-practicing entities” (NPEs) or “patent assertion entities” (PAEs). Though the most controversial NPEs are investor groups that buy their patents on the open market, the term also encompasses small inventors and universities, for instance, which also don’t typically “practice” their own patents—i.e., sell products or services incorporating the patented invention. Champions of NPEs say they merely enable small inventors to vindicate their rights against enormous corporations that would otherwise pilfer their inventions with impunity.
One of the two cases being argued today, Octane Fitness v. ICON Health & Fitness, presents the question of precisely which standard a court should use in determining whether the bringing of a unsuccessful patent case has been so outrageously baseless as to warrant fee-shifting. Though Octane Fitness does not involve an NPE, it arises from another recurring situation that can lead to abuse: a large operating company suing a small competitor for infringing a patent that the large company does not itself practice.
The companion case, Highmark Inc. v. Allcare Health Management Systems, concerns a related question: How much deference should the appeals court—which, in patent cases, is always the U.S. Court of Appeals for the Federal Circuit—give to a lower court’s decision to award fees to a defendant. In that case the district judge ordered an NPE called Allcare to reimburse the attorney’s fees of Highmark, a nonprofit health insurer in the Blue Cross Blue Shield network, but his ruling was partially overturned on appeal, in part based on arguments the NPE could have made, but never did, in the lower court.
The Octane Fitness case involves litigation between two manufacturers of elliptical training machines. ICON, the older, larger, more diversified company—NordicTrack is one of its numerous brands—patented a linkage system for an elliptical training machine in the 1990s. It never commercialized that patent, however, and when it marketed its own elliptical machine it chose to pay to license someone else’s patented linkage system. (Octane’s lawyers, led by Rudolph Telscher, Jr., of Harness, Dickey & Pierce of St. Louis, claim that ICON didn’t use its own patented process because its idea “did not work.”)
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Octane Fitness began selling elliptical machines in 2002, and by 2008 was enjoying considerable market success. That year ICON sued it under its unused patent, which one company official described in an email at the time as “an old patent we had a long time that was sitting on the shelf.” ICON filed its case in Los Angeles, even though neither company was based there, a move Octane claims was intended to maximize costs. (ICON is based in Logan, Utah, while Octane is based in Brooklyn Park, Minnesota.)
In June 2011, after Octane succeeded in transferring the case to Minnesota, the district judge threw the case out on summary judgment, finding that “multiple” elements essential to proving infringement were missing. By then Octane had run up about $2 million in attorney’s fees defending the case. It asked the judge to order ICON reimburse its fees.
The judge declined, applying a rigid, two-part test that the appeals court for the Federal Circuit has required lower courts to follow since 2005. The Federal Circuit affirmed and the Supreme Court then elected to hear the case.
As things currently stand, for a defendant to win recovery of its attorney’s fees (in the absence of outright litigation misconduct or fraud on the Patent Office) it must show that the plaintiffs’ claims were both “objectively baseless” and “brought in subjective bad faith.” Moreover, both aspects of this test must be proven by “clear and convincing” evidence—a burden of proof more rigorous than the usual “preponderance of the evidence” standard typically used in civil cases.
“This rigid framework places an insurmountable burden on successful accused infringers, like Octane, particularly where the injustice of the case lies predominantly in the weakness of the patent contentions,” Octane’s attorneys argue in their brief. Octane asks for the Court to permit the district judge to simply consider the “totality of the circumstances” in deciding whether an award is appropriate.
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In response, ICON’s attorneys—led at the Supreme Court level by Carter Phillips of Sidley Austin—argue that “virtually any [unsuccessful] patent infringement case will qualify” for fee-shifting if the standard is so amorphous as the one Octane proposes and can be applied to cases like this one.
The issue requires interpreting a fairly vague statute. The general rule in America is that losing parties pay their own fees. In 1946, Congress altered that rule to the extent of allowing a court in a patent case to award fees to the prevailing party “in its discretion.” In 1952, the language was changed to permit fee-shifting “in exceptional cases.”
Though everyone agrees that fee awards should be rare, the question is how rare. The extremely demanding test the Federal Circuit adopted in 2005 was lifted from the realm of antitrust law, where it describes the high wall that the Supreme Court has required to be scaled before it will permit one company to bring an antitrust suit against another for having initiated “sham litigation” against the first.
The U.S. Patent and Trademark Office and the White House, through Solicitor General Donald Verrilli, Jr., are supporting Octane Fitness’s call for adopting the “totality of the circumstances” test. In three separate briefs, so are 14 tech companies led by Google (GOOG); an unsual mix of seven companies, ranging from Yahoo (YHOO) to Medtronic (MDT) to The New York Times Co. (NYT) to General Mills (GIS); and, acting alone, Apple, which describes itself as “the firm most targeted by” patent assertion entities. Apple has been involved in 92 such litigations in the last three years, it says.
Thirty states have also gotten involved, arguing in their joint brief that “patent enforcement practices” have become a “consumer protection problem.” Their interest stems from the recent spate of instances in which NPEs have sent demand letters to unsophisticated Main Street businesses—mom-and-pop groceries, cafes, small businesses, and nonprofits—alleging that the operation of some scanning machine, wi-fi router, or other piece of routine office equipment on their premises violates a patent the NPE holds. (The states’s brief is written by the attorney generals of Vermont and Nebraska, William Sorrell and Jon Bruning, respectively.)
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U.S. Solicitor General Verrilli’s brief is surprisingly outfront in arguing that NPEs present a special problem for society. While a plaintiff’s status as a “specialized patent assertion entity” should not “in and of itself” count against it for purposes of a fee-shifting analysis, Verilli writes, he seems to regard it as a red flag. Such entities “typically do not face (and are often structured to avoid) the normal disincentives to filing vexatious or frivolous infringement claims,” he argues, citing the fact that they are “not vulnerable to infringement counterclaims and may face little reputational risk from pursuing aggressive litigation strategies” because many are set up as “shell companies” and don’t need to worry about consumer backlash.
“For a subset of such patent-assertion entities, moreover, litigation is not a cost but a method of doing business designed to extract serial settlements from multiple defendants,” Verilli continues. “For these reasons, non-practicing firms appear to have contributed to an upsurge in recent patent litigation.” (President Barack Obama has made curbing “patent trolls,” as he called them in a February 2013 “
Fireside Hangout
” on Google+, a priority, and he called for patent reform legislation to end “needless litigation” in his State of the Union address last month.)
On the other hand, a group of older Fortune 500 companies, representing more traditional American industries—including 3M (MMM), General Electric (GE), Procter & Gamble, and Johnson & Johnson (JNJ)—urges that “it would be a mistake to hold any particular class of patent litigants at fault.” These companies, in a brief written by Pratik Shah of Akin Gump Strauss Hauer & Feld, argue that “non-practicing patentees . . . routinely play critically productive roles in fostering innovation and creating economic growth in this country through the invention, pre-commercial development, and licensing of their intellectual property rights to others who are better positioned to commercialize their technical breakthroughs.”
Still, in the end, even these companies conclude that the Federal Circuit’s existing standard for fee-shifting is too high, “misses the forest for the trees,” and should be changed to the “totality of the circumstances” test.
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Perhaps most tellingly of all, even the New York Intellectual Property Law Association—a reliable supporter of the status quo and a group that considers the patent troll problem to be largely a figment of the popular media’s imagination—acknowledges in its submission that the Federal Circuit’s current standard is “slightly” too high. It urges keeping, nevertheless, the Federal Circuit’s two-pronged structure, and counsels only highly nuanced tweaks in the language of each prong.
Some change looks likely. “It seems clear,” writes Timothy Holbrook, a law professor at Emory University School of Law, in an email, “that the Supreme Court will make it easier for prevailing defendants to get their attorneys paid by losing patent holders. Any effort in this regard may preempt efforts in Congress to make the patent system a ‘loser pays’ one.”
The ruling could make a difference, too. “My sense is that the biggest tool in deterring unmeritorious troll litigation is to give the district court greater ability to award fees,” says Mark Scarsi, a partner in Milbank’s Los Angeles office, who has defended many NPE cases. (Scarsi won a jury verdict for Apple last November in a suit brought by one in reputedly plaintiff-friendly Marshall, Texas.)
“A smart district court judge, after living with a patent case for a year or so, knows whether it should have never been brought in the first place,” continues Scarsi. “A ‘totality of the circumstances’ approach would provide the flexibility to make the potential award of fees a real tool in deterring bad patent cases.”
Still, even many who hope the Supreme Court will make fee-shifting easier fear an overreaction, too. “If the court can apply the right texture to its ruling,” says Dave Kappos, the former director of the U.S. Patent and Trademark Office and now a partner at Cravath Swaine & Moore, “it can significantly reduce abusive lawsuits, but do that without chilling the ability of good-faith innovators to protect their patent rights. This last point is critical, because those ‘good-faith innovators’ are frequently today’s Edisons—small companies and independent inventors who have the audacity to challenge norms and thereby make the breakthroughs that have so uniquely characterized the American inventive spirit.”