By Kyoungbo Sim, Fellow at KDI
※ This article is part of KDI Journal of Economic Policy, May 2020
The two fundamental pillars of patent remedies are awarding patent damages and issuing an injunction. In the U.S., it was a general rule that the court awarded patent damages to compensate the patent holder for prior infringement and granted a permanent injunction to prevent continuing infringement if the court found the patent valid and infringed upon. However, since around the early 2000s, there has been vigorous debate regarding the prospect of hold-up problems associated with injunctions in patent cases. Subsequently, the U.S. Supreme Court made a substantial change to the prospective remedy. In eBay v. MercExchange, the Supreme Court instructed the district courts to exercise discretion as to whether to grant or deny injunctive relief depending on results of a four-factor test.
Concerns over patent hold-up associated with injunctions grew rapidly after the well-known patent dispute between NTP and Research in Motion (RIM). After RIM had successfully launched Blackberry, a device offering wireless email service, NTP asserted that RIM infringed on NTP’s patents. In the patent lawsuit, the jury found that NTP’s patents were valid and RIM had infringed upon those patents. Subsequently, NTP sought an injunction, which would have been resulted in the closure of the Blackberry service if the injunction had been enforced. Because RIM was desperate to avoid the effects of the injunction, RIM settled the dispute by agreeing to pay $612.5 million to NTP, much more than the damages established by the jury.
As illustrated by the NTP case, concerns about injunctions are more common in the information technology sector, including, for example, telecommunication parts and devices, computer software and hardware, and semiconductors. (Shapiro, 2010) There could be many reasons for this, but to name a few, first, firms in this sector are more easily exposed to the risk of infringing on a patent inadvertently, not only because many patents are of dubious quality and have vague and broad claims but also because products tend to be complex and include many features. Second, a redesign process in response to an allegation of patent infringement can be quite costly and time-consuming.
In many countries, including Korea, however, an injunction is still issued as a matter of course by law if a patent is held valid and infringed upon during patent litigation. Considering that firms in other countries, at least in the information technology sector, may also face a similar situation, a natural question comes to mind, i.e., whether or not Korea should also follow such patent reforms as in US? It is not straightforward to answer this question. Because there has also been criticism that patent remedies in Korea do not provide strong protection for patent holders in terms of the level of patent damage and win rates, any such reforms may worsen the under-compensation problem for the patent holders in Korea.
This paper analyzes how injunctions relate to a patent holder’s payoff when the patent remedy system may not provide enough protection for the patent holder due to aspects other than injunctions. By comparing that payoff to a benchmark level, we identify conditions under which the patent holder is over-compensated by obtaining or threatening to seek an injunction, that is, patent hold-up associated with an injunction arises. Next, according to the analysis, we attempt to draw policy implications for the patent remedy system in Korea. We also briefly discuss several alternatives to injunctions as remedies.
To this end, we present a simple model of licensing negotiations between a patent holder and a downstream firm in the shadow of litigation. More specifically, we consider a model in which the two parties have two different opportunities to negotiate a patent license: one before a patent lawsuit and the other after.
We assume the following litigation process. First, as is often assumed in the recent literature, patents are probabilistic property rights, meaning that patents are held and infringed upon only with some probability of patent lawsuits. We call this type of probability patent “strength” following the literature. Second, both patent strength and patent damage may be discounted to some degree.
To reflect the reality and to take into account key elements which may cause patent hold-up in patent infringement lawsuits, we also assume that the redesigning process is costly once the product of the downstream firm is designed to incorporate the patented feature, as in such cases, the initial investments are specific to the patented technology and thus sunk. In a similar vein, we consider the scenario associated with the “inadvertent infringement” model, in which the downstream firm is unaware of the patent when initially designing its product. We also analyze the “early negotiation” model in which the downstream firm can contemplate whether to incorporate the patented feature into its product while remaining aware of the patent and then compare the results from the two models.
In the inadvertent infringement model, we show that patent hold-up problems are worrisome when (i) the redesign process is costly, (ii) patent strength discounting and patent damage discounting are not too large, and (iii) the patent holder obtains or threatens to seek an injunction not to exclude the downstream firm from practicing the patent but to collect excessive patent royalties. If the injunction is granted but the patent holder still wants to license the patent to the downstream firm, the patent holder captures part of the redesign cost regardless of the value of the patented technology, which potentially causes the patent holder’s payoff to exceed the benchmark level. However, if patent strength discounting and patent damage discounting are too large, capturing part of redesign cost would not be sufficient to compensate for the loss caused by the weak patent protection. Our results also indicate that a perfect degree of patent protection is not a prerequisite for a patent reform such as the recent one in the US.
The patent hold-up problem can arise even in the early negotiation model. Two different patent hold-up types can emerge. In case the downstream firm decides to use the patented feature after the initial negotiations break down, we see the same type of hold-up problems directly associated with the threat of an injunction. In contrast, if the downstream firm decides not to incorporate the patented feature into its product, we see a different type of hold-up problem. In these cases, the patent holder is over-compensated mainly because the downstream firm withdraws a chance to fight for the invalidation of the patent or defend the infringement allegation. This type of hold-up is especially serious for weak patents.
This paper contributes to the literature on the patent hold-up issue. Many studies have shed light on hold-up problems in a standard setting context. Among others, Farrell et al. (2007) offers an excellent overview of related issues. The key issue here is that the bargaining power of a patent holder during license negotiations increases dramatically once a technical standard, including technology protected by a patent holder’s patent, is established as an industry standard. The patent holder can then collect much higher royalties than would have been determined before the standard was adopted or before the downstream firm decided to incorporate the standard into its product. Papers in this strand of the literature mainly focus on finding a good way to discipline opportunistic behavior by patent holders through the use of antitrust or patent laws or on studying whether FRAND commitments made by patent holders can effectively mitigate hold-up problems. For example, Ganglmair et al. (2012) develops a model in which a patent holder, who abides by a FRAND commitment, and a downstream firm engage in royalty negotiations. They show that FRAND can indeed mitigate a hold-up problem but that it also retards innovation by reducing the patent holder’s payoff. They also suggest that an option-to-license contract under which the patent holder and the downstream firm negotiate before any standardspecific investment by the downstream firm is made can outperform the FRAND commitment. In comparison to these works, we attempt to examine hold-up problems associated with injunctions in more general patent license negotiations. Studies by Shapiro (2010; 2017) are more closely related to this paper in that those studies focus on licensing negotiations between a single patent holder and a single downstream user. Shapiro (2010) analyzes conditions under which hold-up problems arise, confining his attention to cases in which the patent holder is a non-practicing entity (NPE). Shapiro (2017) investigates conditions under which ongoing royalties outperform injunctions, also confining his attention to cases in which the court already has discretion as to whether to grant an injunction or to order ongoing royalties, and where the patent has already been found valid and infringed upon. Because we must consider the possibility that the patent remedy system may not provide enough protection for the patent holder due to aspects other than injunctions, our model integrates and extends the above two models. More specifically, we analyze how both remedies for past and future infringements affect the patent holder’s payoff considering license negotiations before and after litigation and general competitive relationships between patent holders and downstream users.
Lemley and Shapiro (2007) briefly discuss patent hold-up caused by injunctions but focus more on royalty stacking, which refers to situations in which a single downstream user takes a risk of infringing on many different patents owned by different patent holders. They demonstrate how royalty stacking can amplify holdup problems in a relationship between a single-downstream user and a multiple-patent holder.
This paper is also related to a number of studies exploring more sophisticated litigation strategies of NPEs. Choi and Gerlach (2018) and Hovenkamp (2013) study how a NPE can more effectively assert their patents while facing multiple potential infringers. Choi and Gerlach (2018) examine the effects of an information externality produced by a prior litigation outcome on subsequent litigations. Assuming asymmetric information between the NPE and downstream users with regard to the type of NPE, Hovenkamp (2013) studies the incentives of NPEs to initiate litigation in the early stage to build a litigious reputation for subsequent litigation. Lemus and Temnyalov (2017) analyze the roles of NPEs when practicing entities can outsource the filing of lawsuits against one another to a NPE and show that the existence of NPEs may increase both the innovation incentives of practicing entities and social welfare.
A number of works in Korea study patent hold-up problems as well. Many of them, such as Cha (2015), Oh (2014) and Song (2014), examine whether the court needs to deny an injunction in a patent infringement case if a plaintiff owns standard essential patents under a FRAND commitment. Several other studies, including those by Cho (2015), Sim (2013) and Son (2011), examine hold-up problems created by injunctions in more general cases of patent licensing. However, while all of the studies discussed above offer insights from a legal perspective, they do not provide a sufficient theoretical background. Moreover, despite the fact that there has been criticism that patent remedies in Korea do not provide strong protection for patent holders, as in Kim (2015), previous works do not seriously take into account such criticism.
The remainder of the paper is organized as follows. Section 2 presents the model. In section 3, we discuss the benchmark royalty rate and payoffs. In sections 4 and 5, we study the inadvertent infringement model and the early negotiation model respectively, in turn. Section 6 discusses policy implications and a few alternative remedies to an injunction. Finally, section 7 concludes the paper.
※ This paper is based on Sim, Kyoungbo, 2018, A Study on Limiting the Right of Patent Owners to Seek Injunctive Relief for Patent Infringement
, Policy Study 2018-15, KDI (in Korean)).