Patent reform inches onwards but poison pill could kill it

All of this raises the stakes for the end game in this year’s bipartisan patent reform push, which comes after a similar effort last year was smothered unexpectedly by former Senate majority leader Harry Reid (D-Nevada). According to people close to the issue, patent reform remains possible, but this week’s Senate surprise as well as a tight political clock could cause it to fail once again.

Tech and retailers take it to the trolls

The business of patent trolling is an ugly one. Shell firms, often owned by lawyers and private equity, acquire old patents and then threaten productive companies with expensive litigation until they pay for a “technology” license they don’t need. The troll model has been wildly successful thanks to a giant supply of suspect patents, and because of an economic asymmetry that makes it cheap for trolls to attack but ruinously expensive for defendants to fight them in court.

The trolls have filed thousands of lawsuits in recent years, and extracted an untold number of quiet payments (troll settlements typically require victims to stay mum) from a wide sector of the American economy: startups, big banks, major retailers, and even mom-and-pop stores and coffee shops.

Tech companies have tried to fix the system for years, but keep coming up short. This year, however, the prospects for patent reform improved thanks to an unusually broad coalition that included not just the usual suspects (Google, Facebook, et al.), but also main street outfits like Macy’s, JC Penney, restaurants, and the National Retail Federation. Startups and small businesses have also joined in through trade groups like Engine.

To strike at the trolls, the coalition landed on a series of measures intended to undercut the economic incentives for patent trolling. These include heightened pleading standards for legal complaints (existing rules don’t require trolls to explain how their targets violate a patent) and changes to the legal discovery process—under current discovery rules, trolls can force companies to spend hundreds of hours in document searches and executive depositions without even showing a serious case. Other measures include stopping abusive “demand letters,” fee-shifting, and a “real party in interest” rule that would force the trolls, who hide behind trumped up tech-sounding names like “Innova,” to reveal who is bankrolling them.

Taken together, the proposed reforms would make patent trolling less of a no-risk, high reward endeavor. But despite their seemingly commonsense appeal, such reforms have foundered twice before. In 2011, President Obama signed a patent reform bill known as the America Invents Act into law, but the substance of it was largely gutted by the time it reached his desk. And last year, a bill similar to the current offering sailed through the House of Representatives, only to be killed at the 11th hour in the Senate by Sen. Reid.

Currently, patent reform is still alive but on a knife edge. Supporters this week were heartened by a 16-4 vote in the Senate Judiciary Committee in favor of a reform bill, and by the role of Committee Chairman, Sen. Chuck Grassley (R-Iowa), who, unlike his predecessor Reid, has proved a big supporter of the measure. Meanwhile, the bill is still being championed by the powerful, odd-bedfellows duo of Senators Charles Schumer (D-N.Y.) and John Cornyn (R-Texas).

So far, so good. But the whole thing could unravel by July.

Pharma’s poison pill

The pharmaceutical industry wields vast power in Washington and is suspicious of patent reform. Unlike the junky software patents that are the trolls’ stock in trade, pharma patents are often obtained only after companies invest huge amounts of money in bio-chemistry research and clinical trials. That’s why the pharma lobby will rush to stamp out any measure that could weaken intellectual property.

The current slate of reforms—ending discovery abuse, heightened pleading and so on—was designed to strike at trolls without affecting the pharma industry. And all appeared to be going as planned until a recent event gave the pharma industry, which had stayed on sidelines, the jitters.

That event came in the form of a challenge to a biotech patent, filed by hedge-fund manager Kyle Bass, who hoped the challenge would spook the share price of Jazz Pharmaceuticals (JAZZ), and allow him to profit from shorting the stock. (In an ironic twist, Bass’s gambit involved teaming up with Eric Spangenberg, whose previous act was as a notorious patent troll who once bragged to the New York Times that he liked to “go thug” on patent defendants).

The Bass challenge does not appear to have dented Jazz’s stock, but just the threat was enough for the pharma lobby to stick its very long nose into the patent reform effort underway in Congress. The concession it asked was an enormous one: The industry demanded that Congress effectively cripple the process at the Patent Office where Bass had challenged the Jazz patent.

That process, known as inter partes review, is one of the few successes to emerge from the America Invents Act of 2011. The process allows the public a relatively quick way to ask officials at the Patent Office to take a second look at patents that should not have been issued in the first place. In its short existence, it has proved effective at weeding out some notorious software patents (including a patent on all podcasts) that are the troll industry’s favorite weapon.

But despite evidence from scholars that the process has invalidated a relatively small number of patents, the pharma industry has persuaded Grassley in the Senate to adopt an amendment that would effectively sabotage the challenge system.

According to Krish Gupta, counsel for cloud storage giant EMC, the amendment changes the evidence and pleading rules for the inter partes review process. According to Gupta, this will make the challenge process akin to full-blown patent litigation, and eliminate the incentive for companies to use it. For companies like EMC (EMC), which has been a frequent target of patent trolls, this would be a major setback.

In Gupta’s view, the pharmaceutical industry is overreacting to the Bass incident, especially as there is little evidence that inter partes process poses a serious threat to the industry’s patents. But its reaction may be enough to sink the larger push for patent reform once again.

The end game

The price of pharma’s poison pill may be too high for the tech and retail coalition, according to a person familiar with the legislation. After seeing patent reform fail twice in five years, the coalition may prefer to walk away than to grant a concession that would amount to giving away as much as it gets, said the person who spoke on condition of anonymity.

This doesn’t mean a final deal is out of reach, of course. In the course of this week’s Judiciary Committee hearing, several Senators suggested the final language of the bill is up for debate, raising the prospect of a carve-out to placate the pharmaceutical industry. But to get there will still require patent reform supporters to run a gauntlet of procedural measures, and it’s not clear they have time to do so.

As it stands, the reform measures must go to a vote before the full House and Senate, and then members of both chambers will have to reconcile the two versions before voting again on a final bill. President Obama, who is a longtime supporter of patent reform, is likely to sign a bill if it ever reaches his desk.

In theory, patent reform could pass by August, but that leaves lots of time for opponents, who also include trial lawyers and Sen. Dick Durbin (D-Ill.), to find new ways to stymie the measure. If they are able to delay the measure beyond late recess, the political window for action will likely close and the trolls will be able to run free until at least 2017.

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