The Parable of the PTAB and the Faulty Steel Support Beams

USPTO Building

“The US patent system was ranked 10th worldwide by the US Chamber of Commerce.  Until this year, it was always ranked first. Census data released late last year found that in 2014, the creation of new startups was at or near a 40-year low, and I’m hearing more and more anecdotes about investors asking if a patent portfolio includes patents in China and Europe because those are viewed as necessary for getting effective enforcement against infringement.” – Senator Chris Coons

 

Mitch Kline Profile Picture  by: Mitch Kline | December 7, 2017

It had been a good year for the Panels, T-beams, and Ball Bearings Company (we’ll call it the “PTAB” for brevity). The PTAB beat revenue estimates for the quarter, owing to the success of their new steel support beams, which had become ubiquitous in the construction of commercial buildings and skyscrapers. The company found that it could source suitably sized steel ingots from its supplier, melt them down, and reform each one into a support beam. The process was inexpensive, and the company sold the beams at a relatively high margin.

But the PTAB had a problem. Following a number of mishaps, an internal investigation determined that as many as 50% of the company’s support beams were not structurally sound, and did not comply with regulations. The source of the problem turned out to be the steel ingots, some of which contained impurities that compromised their tensile strength.

Framing the situation as an existential threat to the company, the CEO engaged an army of consultants, experts, and academics to help determine how best to proceed. After months of deliberation, calculation, prognostication, and argumentation, the proclamation finally came:

“We’ve found a solution!” The CEO stood proudly before the board. With a casual flick of the wrist, he flipped to the next slide of his presentation, and began pacing around the boardroom table.

“Moving forward, we will create a task force to inspect buildings once they have been constructed with our support beams. With a small scraping of a beam, we can perform a test to detect the relevant impurities.”

Silence. The board members watched with anticipation, as the CEO continued to pace. “If our tests reveal that a beam lacks the necessary structural integrity, we will have the building condemned—effective immediately.”

“But developers invest hundreds of millions of dollars to construct these buildings,” one of the board members posited.

“People’s lives are at risk,” retorted the CEO. “No. This is our only option.”

Everyone around the table rose for a standing ovation. The policy was implemented, and there was much rejoicing. Over the next several years, hundreds of new buildings were constructed and condemned, billions of dollars invested were wiped off the books, and there was much rejoicing. Eventually, developers shifted their efforts and investments to China, where they were confident their buildings would not be condemned. As the skylines of Chinese cities flourished, those of American cities stagnated in perpetuity.

…and there was much rejoicing.

Debrief

I realize that not everyone reading this has the benefit of an MBA or a career at McKinsey, so I’ll break it down for you, and let you in on what all the fuss is about. Described above is an unenlightened solution, with horrific consequences. Somewhere, a management consultant just threw up in her mouth. But this is the construction materials equivalent of what Big Tech lobby’s rhetoric would have you believe is a perfect world.

The argument is as follows: The US Patent and Trademark Office routinely errs by issuing invalid patents; these patents are used by bad actors to extort royalty payments out of operating companies; therefore, we need an expeditious process by which the Patent Trials and Appeals Board (we’ll call it the “PTAB” for brevity) can invalidate patents before too much money is wasted litigating.

For the sake of argument, let’s accept the premises. Through Inter Partes Review (IPR), the PTAB has invalidated at least one claim in 44%[1] of the patents it has considered. If we trust the PTAB’s determinations (there is certainly reason to be skeptical), then the first premise seems reasonable. From my experience licensing patents, I can tell you that there is no viable business model premised on using invalid patents to extort royalty payments, but we’ll let that one slide as well.

It’s the conclusion that I’d like to address, and deride anyone who would accept such deranged logic. If you read the parable, and wanted to scream at the CEO, telling him to test the ingots before reforming them into beams, then your instincts are acute. If, indeed, the problem is the rampant issuance of invalid patents, then we should stop issuing invalid patents. A system that awards a patent with a 56% chance of survival creates uncertainty, and uncertainty is bad for business.

The cost of an IPR varies, depending on circumstances, but the median cost is around $250,000 for each side. This can be considered an upper limit on the cost of determining whether a patent is valid, and is an expense that should be shifted to the application stage, where an applicant can find out that his claims are invalid before investing substantial resources. Many companies rely on patent protection to justify the investments of time and capital required to bring new technologies to market.

A side effect of front-loading a rigorous validity determination is that the cost of applying for a patent becomes much higher. My back of the envelope calculations suggest that people will apply for fewer patents, and the decision to apply for a patent will need to be backed by a strong business case. This will reduce the load on the patent office, and trim the thicket of largely useless patents that companies have created with their strategy of throwing everything at the wall (read patent office) and seeing what sticks.

Granted, higher application fees would pose a barrier for small companies and individuals to obtaining patent protection. However, the truth is, that barrier already exists—it’s just hidden. Currently, patent protection for small entities is an illusion, as the expense of litigation and defending an IPR against an infringer is prohibitive (especially when adjusted to incorporate the risk of invalidation). If the cost is shifted to the application stage, an applicant knows, and can better plan for, the expenses associated with making use of the patent system.

“Property rights are fundamental: entrepreneurs will not invest if they expect to be unable to keep the fruits of their investment. Country-level studies consistently show that less secure property rights are correlated with lower aggregate investment and slower economic growth.”[2]

Business thrives on certainty and predictability. Property rights cannot perform their purpose if they are ephemeral. We cannot use bad patents as an excuse to weaken the patent regime, and the property rights it establishes. If we agree that bad patents are a problem, let’s find a solution that doesn’t condemn our buildings after we’ve invested to build them. There will be much rejoicing.

Footnotes:

[1] This number removes the IPRs that were terminated before the trial was completed (due to settlement, etc.) from the total number of petitions filed.

[2] Johnson, Simon, John McMillan and Christopher Woodruff. “Property Rights And Finance,” American Economic Review, 2002, v92 (5,Dec), 1335-1356.

 

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