If Your Startup Really Is Disruptive, Expect to be Sued By a Patent Troll.

Legacy companies that have neglected to innovate often instead compete by filing costly IP lawsuits potential competitors struggle to afford.

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By Tim Molino

Sofie Delauw | Getty Images

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It's an all-too-familiar story: a young company or start-up has an exciting new offering. Success captures the attention not just of new customers, but alsoi of large patent holders sensing an opportunity to assert their patents. As a former patent litigator, I've represented many small businesses sued by larger, more established operating companies.

With all the demands of growing a new business, intellectual property often takes a back burner but ignoring potential IP risks can have dire consequences.

The story of small companies being targeted isn't new -- incumbent firms have long threatened patent litigation to slow down new entrants or bolster declining revenues. A combination of factors in the late 1990s and early 2000s made it easier to do this: the rise of internet and ecommerce patents; court decisions that made patents easier to get and harder to invalidate; skyrocketing costs for defending patent suits; and legal rules that gave patent plaintiffs the upper hand in litigation. The threat of an injunction and the high costs of litigation often forced defendants to settle for large amounts of money, even if they believed the patent was invalid or worth very little.

Over the past decade, a number of policy changes by the Courts, Congress and the US Patent and Trademark Office have reduced some of the abuses in patent litigation – but mostly to the benefit of large companies. Important Supreme Court rulings and the America Invents Act have made great strides in reforming the system, which has enabled larger businesses to defend against abusive patent assertions. For start-ups and small businesses, however, significant challenges remain. The fact is that smaller businesses often don't have the money for an expensive, drawn-out legal battle and are much more sensitive to legal risk when seeking pre-IPO investment.

Related: More Bad News for Patent Trolls

This vulnerability is compounded by the growing reliance of small companies on third-party technology, which has become critical to their business. The dot-com boom and the rise of ecommerce revolutionized businesses, large and small, in nearly every industry. The second wave of this digital transformation is now underway with the transition of businesses to cloud computing. For small businesses, cloud computing is becoming essential for every business function -- internal and external communications, bookkeeping, advertising, payment, order fulfillment, etc.

For many, the digital transition has lowered barriers to entry, reduced time to market and decreased the initial capital costs of starting a business, all of which allows new and small companies to compete more effectively with larger incumbents. However, as with any major technology shift, it also brings a new set of challenges and vulnerabilities, especially in IP. In recent years, the increased reliance of businesses on new, widely-adopted technologies has been the catalyst for some of the most notorious patent abuses, from MPHJ Technology Investment's targeting of 16,000 small businesses for using the "scan to email" function to Innovatio's assertion against thousands of hotels and cafes for providing free Wi-Fi access.

Related: IBM Is One of the World's Biggest Patent Trolls

While patent litigation trends are not as high as their peaks a decade ago, a growing number of indicators point to "non-practicing entities" (NPE) - defined as "a patent owner who does not manufacture or use the patented invention" -- focusing their litigation efforts on cloud computing, hoping it will be the next big monetization opportunity. With the rise of the internet in the late 1990s and early 2000s, patents pertaining to internet and basic business applications such as email became 7.5 to 9.5 times more likely to end up in infringement litigation than non-internet patents, according to a study published in the Stanford Technology Law review. Today, that patent assertion focus is shifting to the cloud. Since NPEs earn their living through assertions, it is no surprise they tend to follow prosperous emerging sectors that offer rich litigation opportunity.

The cloud platform creates an ideal opportunity for NPEs and unscrupulous competitors to leverage internet-era patents into money from a broad spectrum of companies using standardized cloud technology/platforms. The worst serial patent litigators actually prefer small businesses: roughly 66 percent of defendants in these suits are companies with less than $100M in annual revenues. More than half -- 55 percent -- make under $10M per year.

The patent system does not afford sufficient protection for these smaller defendants that already face significant business risk. A UC Santa Clara study found that 40 percent of small companies involved in NPE litigation reported a "significant operational impact," including delayed hiring or achievement of key milestones, change in the product, a pivot in business strategy, a shut-down business line or entire business, and/or lost valuation. Some have described receiving one of these demands as a "death knell."

Related: Chief Justice John Roberts Calls U.S. Patent Challenge Process Bizarre

So, while IP litigation has fallen off a bit from the heyday of the early 2000s, the migration to cloud-based technologies has the potential to expose small businesses to new IP risks, as we have seen play out during other major technology shifts. The good news is businesses today have more and better tools to defend themselves against aggressive patent owners, thanks in part to efforts by technology providers to ease adoption by helping address IP risks. The LOT Network, spearheaded by Google, aims to reduce the risk of NPE litigation through community licensing. Microsoft's Azure IP Advantage Program helps customers manage patent risks by providing expanded indemnification and the ability to pick one of 10,000 patents to use to fight back in litigation brought by a competitor or other operating company. Amazon recently added basic indemnification to AWS, but its protections still lag behind those of Google and Microsoft. While neither will end abusive patent assertions entirely, these private sector initiatives are a solid step toward addressing IP vulnerabilities associated with adopting new technology.

Major technology shifts happen because the enormous benefits of a new technology outweigh the risk of adoption. The transition to cloud computing is no exception. However, given the historical precedents, companies of all sizes should consider the impact of cloud adoption on IP risk and develop IP strategies to protect themselves in this new landscape. Considering the pain caused by the patent battles of the internet era, we would all be better off learning from history, rather than repeating it.

Tim Molino

IP Policy Consultant

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