BILL ANALYSIS                                                                                                                                                                                                    





                             SENATE JUDICIARY COMMITTEE
                         Senator Hannah-Beth Jackson, Chair
                            2015 - 2016  Regular  Session


          SB 681 (Hill)
          Version: February 27, 2015
          Hearing Date:  April 21, 2015
          Fiscal: Yes
          Urgency: No
          TH   
                    

                                        SUBJECT
                                           
                                 Civil Law:  Patents

                                      DESCRIPTION  

          This bill would make it unlawful to send a written communication  
          stating that the recipient may have infringed on a United States  
          patent if, in bad faith, the sender makes specified statements,  
          seeks compensation for specified conduct, or fails to include  
          specified information in the communication.  This bill would  
          also provide specific remedies for sending such unlawful  
          communications, and would specify that those remedies may only  
          be obtained by the Attorney General or an attorney acting on  
          behalf of the state.

                                      BACKGROUND  

          In recent years, much attention has been focused on the business  
          model practiced by certain firms that make money not by  
          producing goods, but by licensing patent use or asserting patent  
          claims against other companies that produce goods using patented  
          technologies and methods.  The activities of these so-called  
          "patent trolls," "non-practicing entities," or "patent  
          monetization entities" are thought by some to be harming  
          innovation and causing the market as a whole to reduce venture  
          investing and research and development spending.  Whether or not  
          these entities actually harm the market is a hotly debated  
          topic, as is the nature of what - if anything - should be done  
          about it.  Indeed, even the definition of who constitutes a  
          non-practicing entity is contentious, with some commentators  
          pointing out that the concept may include universities that  








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          license use of their patents.

          This bill would create a new civil infraction designed to  
          address the problems caused by non-practicing entities that  
          allege patent infringement claims in bad faith.  The bill would  
          make it unlawful to send a written communication stating that  
          the recipient is or may be infringing, or has or may have  
          infringed, on a United States patent if the sender of the  
          communication, in bad faith, makes a specified statement, seeks  
          compensation for specified conduct, or fails to include  
          specified information in the communication.  As a remedy, the  
          bill would provide that a person who sends a communication in  
          violation of these provisions may be enjoined and is liable for  
          a civil penalty of up to $2,500 for each violation.  Such  
          remedies may be sought solely by the Attorney General or an  
          attorney acting on behalf of the state.  This bill would  
          additionally provide that it shall be an affirmative defense  
          that the sender did not act in bad faith if the sender  
          demonstrates that the statement, representation, or omission at  
          issue was a mistake made in good faith.

                                CHANGES TO EXISTING LAW
           
           Existing federal law  , the United States Constitution, reserves  
          to Congress the power "to promote the progress of science and  
          useful arts, by securing for limited times to authors and  
          inventors the exclusive right to their respective writings and  
          discoveries."  (U.S. Const., art. I, Sec. 8.)

           Existing federal law  , the Patent Act, provides for the issuance  
          of patents to any person who invents or discovers any new and  
          useful process, machine, manufacture, or composition of matter,  
          or any new and useful improvement thereof.  (35 U.S.C. Sec.  
          101.)

           Existing law  , the Unfair Competition Law, renders an individual  
          liable for any unlawful, unfair or fraudulent business act or  
          practice and any unfair, deceptive, untrue or misleading  
          advertising.  (Bus. Prof. Code Sec. 17200.)

           Existing law  provides that one who willfully deceives another  
          with intent to induce him to alter his position to his injury or  
          risk, is liable for any damage which he thereby suffers.  (Civ.  
          Code Sec. 1709.)








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           This bill  would render it unlawful for a person, in connection  
          with the assertion of a United States patent, to engage in a  
          pattern or practice of sending written communications that state  
          or represent that the recipient is or may be infringing, or has  
          or may have infringed, the patent and is liable or owes  
          compensation to another, if specified conditions are met.

           This bill  would specify that it is unlawful for the sender of  
          the written communication to make, in bad faith, any of the  
          following statements or representations:
           that the sender has the right to license or enforce the patent  
            at the time the communications are sent, if the sender is not  
            a person with that right;
           that a civil action asserting a claim of infringement of the  
            patent has been filed against either the recipient or against  
            other persons;
           that legal action for infringement of the patent will be taken  
            against the recipient;
           that the sender is the exclusive licensee of the patent  
            asserted in the communications;
           that persons other than the recipient purchased a license for  
            the patent asserted in the communications;
           that persons other than the recipient purchased a license, and  
            the sender does not disclose that the license is unrelated to  
            the alleged infringement or the patent asserted in the  
            communications;
           that an investigation of the recipient's alleged infringement  
            has occurred; or
           that the sender, or an affiliate of the sender, previously  
            filed a civil action asserting a claim of infringement of the  
            patent based on the activity that is the subject of the  
            written communication when the sender knew that the activity  
            was held, in a final determination, not to infringe the  
            patent.

           This bill  would specify that it is unlawful for the sender of  
          the written communication to seek, in bad faith, compensation  
          for any of the following:
           a patent claim that has been determined to be unenforceable or  
            invalid against the recipient in a final determination;
           activity undertaken by the recipient after expiration of the  
            patent asserted in the communication; or
           activity of the recipient that the sender knew was authorized,  
            with respect to the patent claim that is the subject of the  
            communication, by a person with the right to license the  







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            patent.

           This bill  would specify that it is unlawful for the sender of  
          the written communication to fail, in bad faith, to include any  
          of the following in the communication:
           the identity of the person asserting a right to license the  
            patent to, or enforce the patent against, the recipient,  
            including the identity of any parent entity and the ultimate  
            parent entity of the person, unless that person is a public  
            company and the name of the public company is identified;
           identification of at least one patent issued by the United  
            States Patent and Trademark Office alleged to have been  
            infringed;
           identification, to the extent reasonable under the  
            circumstances, of at least one product, service, or other  
            activity of the recipient that is alleged to infringe the  
            identified patent;
           a description, to the extent reasonable under the  
            circumstances, of how the product, service, or other activity  
            of the recipient infringes an identified patent and patent  
            claim; or 
           a name and contact information for a person the recipient may  
            contact about the assertions or claims relating to the patent  
            contained in the communications.

           This bill  would provide that it is an affirmative defense that  
          the sender of the written communication did not act in bad faith  
          if the sender demonstrates that the statement, representation,  
          or omission was a mistake made in good faith, as specified.

           This bill  would provide that a person who sends a communication  
          in violation of its provisions may be enjoined in a court of  
          competent jurisdiction and is liable for a civil penalty not to  
          exceed two thousand five hundred dollars ($2,500) for each  
          violation, as specified.

           This bill  would provide that, notwithstanding any other law, the  
          Attorney General or an attorney acting on behalf of the state  
          shall have the sole authority to enforce its provisions, and  
          that it shall not be construed to create a private right of  
          action.

           This bill  would also define the following terms:
           "final determination" means, with respect to the invalidity or  
            unenforceability of a patent, that the invalidity or  







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            unenforceability has been determined by a court of the United  
            States or the United States Patent and Trademark Office in a  
            final decision that is unappealable or for which any  
            opportunity for appeal is no longer available; and
           "recipient" means a person who purchases, rents, leases, or  
            otherwise obtains a product or service in the commercial  
            market that is not for resale in the commercial market and  
            that is, or later becomes, the subject of a patent  
            infringement allegation.

                                        COMMENT
           
           1.Stated need for the bill  

            The author writes:

            Patents are essential to encouraging innovation, especially in  
            the information technology and knowledge-based fields that  
            drive much of California's economy. The protections afforded  
            by the federal patent system create an incentive to invest in  
            research and innovation, which creates jobs and raises income.

            At the same time, a number of states are seeking to address  
            bad faith patent activities, such as the mailing of abusive  
            demand letters.  Patent assertion entities (PAEs) generally  
            are holding or "shell" companies that don't manufacture  
            anything but hold a number of patents, typically purchased  
            legally from bankrupt firms.  They make their money by sending  
            threatening letters to companies claiming they have been  
            violating one or more of their (often vaguely defined)  
            patents.  The letters say that if the companies pay the  
            license fees to use their patents, they won't be sued.  Often,  
            PAEs target small- to medium-sized businesses that cannot  
            afford to fight lengthy court battles, so they willingly pay  
            the amount demanded to settle out of court.  PAEs usually  
            request unreasonable fees in light of the alleged infractions  
            and often fail to give companies any details about what the  
            patent in question actually covers or how they allegedly  
            infringed upon it.

            While California's unfair competition law is broad, it does  
            not appear to have been applied in the context of patent  
            demand letters.  Furthermore, as demand letters are  
            pre-lawsuit communications that receive heightened protection  
            under the First Amendment's right to petition the courts and  







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            right to free speech, it is unclear whether the [Unfair  
            Competition Law], which does not contain a scienter  
            requirement, could withstand constitutional scrutiny when  
            applied to demand letters.  By contrast, SB 681 makes clear  
            what practices are prohibited and, consistent with the  
            Constitution, requires "bad faith" on the part of the sender.

            SB 681 empowers the Attorney General to seek a civil penalty  
            from any person or entity that sends bad faith demand letters  
            to the end users of a product or service. This narrowly  
            tailored bill prohibits specific misrepresentations (such as a  
            false claim that legal action has been taken against the  
            recipient), omissions (such as failing to identify the number  
            of the allegedly infringed patent), and abusive practices  
            (such as seeking compensation based on a patent previously  
            found invalid) that patent trolls have used against  
            unsophisticated persons and businesses.

           2.Evidence of Problematic Behavior   
           
          This bill is premised on the proposition that non-producing  
          patent holders who make money by licensing their patents  
          (non-practicing entities) are harmful to the marketplace, and  
          that some who engage in this business model carry out their  
          activities in a manner that borders upon fraud.  As noted above,  
          these premises are highly contested among scholars and  
          commentators.  For example, one recent opinion piece in the Wall  
          Street Journal states:

            Patent-reform activists point out that the number of patent  
            lawsuits has increased by about 60 [percent] since 2000, which  
            they cite as evidence that there is a serious problem with the  
            patent system.  But does the uptick in lawsuits actually  
            indicate such a problem?

            In short, no.  It might instead reflect a healthy, dynamic  
            economy.  Rapid technological advances have spurred more  
            innovation and patents, and courts are now clarifying the  
            nature and boundaries of intellectual property and contract  
            rights.  (Stephen Haber and Ross Levine, The Myth Of the  
            Wicked Patent Troll (June 29, 2014) <  
            http://www.wsj.com/articles/stephen-haber-and-ross-levine-the-m 
            yth-of-the-wicked-patent-troll-1404085391> [as of Apr. 16,  
            2015].)








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          A counterpoint piece in the Harvard Business Review illustrates  
          the opposing position, stating:

            But there is evidence of significant harm.  The White House  
            and the Congressional Research Service both cited many  
            research studies suggesting that patent litigation harms  
            innovation.  And three new empirical studies provide strong  
            confirmation that patent litigation is reducing venture  
            capital investment in startups and is reducing R&D spending,  
            especially in small firms.
            . . .
            The economic burden of today's patent lawsuits is, in fact,  
            historically unprecedented.  Research shows that patent trolls  
            cost defendant firms $29 billion per year in direct  
            out-of-pocket costs; in aggregate, patent litigation destroys  
            over $60 billion in firm wealth each year.
            . . .
            [A]cross a significant number of studies using different  
            methodologies and performed by different researchers, a  
            consistent picture is emerging about the effects of patent  
            litigation: it costs innovators money; many innovators and  
            venture capitalists report that it significantly impacts their  
            businesses; innovators respond by investing less in [research  
            and development] and venture capitalists respond by investing  
            less in startups. (James Bessen, The Evidence Is In: Patent  
            Trolls Do Hurt Innovation, Harvard Business Report (Nov. 2014)  
            <  
            https://hbr.org/2014/07/the-evidence-is-in-patent-trolls-do-hur 
            t-innovation> [as of Apr. 16, 2015].)

          Yet a third article takes a more nuanced view:

            One common criticism of [non-practicing entities] (however  
            that term is defined) is that they initiate patent  
            infringement lawsuits seeking to enforce patents of dubious  
            quality or with questionable infringement claims, and then  
            settling for amounts far less than the defendants' litigation  
            costs.  The story is that NPEs (non-practicing entities) take  
            strategic advantage of the notoriously high cost of patent  
            litigation, which requires several million dollars in  
            attorneys' fees to litigate through the close of discovery.

            There is a little firm empirical evidence supporting this  
            scenario of the combination of dubious patent assertions with  
            low settlement demands.  There is evidence that NPEs settle  







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            more quickly compared to other patent holders, which could  
            indicate the possibility of nuisance settlements.  But there  
            is also evidence that the patents asserted by NPEs are similar  
            to patents asserted by practicing entities.  There is some  
            evidence that the most litigious NPEs lose more often when the  
            cases are taken to a final judgment, but like other types of  
            complex civil litigation, the vast majority of patent cases  
            settle before judgment.  (David Schwartz and Jay Kesan,  
            Analyzing the Role of NPEs in the Patent System <  
            http://patentlyo.com/patent/2012/08/  
            analyzing-the-role-of-npes-in-the-patent-system.html> [as of  
            Apr. 16, 2015].)

          Some commentators suggest that the reason such diametrically  
          opposed viewpoints on the issue of patent litigation abuse have  
          emerged is because "patent litigators appear to be polarizing  
          into a plaintiffs' bar and a defense bar."  (Id.)  Others  
          suggest the debate is more about gaining a competitive advantage  
          in the marketplace:

            There is one basic reason behind the attacks on [patent]  
            trolls: Big Money.  Many patent-intensive products . . . are  
            produced by big corporations that license many patents. . . .  
            These corporations can make higher profits the less they pay  
            to use patented technology they do not own, and higher profits  
            still by paying nothing at all. . . . some corporations are  
            looking to gain a competitive edge by changing the rules of  
            the game.  The strategy is to pass patent-reform legislation  
            that weakens the negotiating position of patent holders.   
            Corporations that pay large sums for patented technologies  
            will point to lawsuits, trolls and anything else that will  
            encourage lawmakers to pass such reforms.  (Haber and Levine,  
            The Myth Of the Wicked Patent Troll.)

          Given the significant disagreement over whether abusive patent  
          lawsuits are, indeed, a problem, the Committee may wish to study  
          this issue in more depth before weighing curative legislation.

           3.Existing Legal Remedies
            
           According to the California Chamber of Commerce, this bill  
          "seeks to prohibit . . . abusive conduct by prohibiting a person  
          from engaging in a pattern or practice of sending [patent  
          infringement] communications in bad faith."  In general, it  
          renders unlawful certain statements when made in bad faith, such  







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          as claims that the sender has a right to enforce a patent when  
          he or she does not, as well as efforts to seek compensation for  
          patent claims that have been determined to be unenforceable or  
          invalid.  This sort of conduct may already be prohibited by the  
          State of California's robust consumer protection laws.

          California's Unfair Competition Law (UCL), as an example,  
          renders an individual liable for any unlawful, unfair or  
          fraudulent business act or practice and any unfair, deceptive,  
          untrue or misleading advertising.  (Bus. Prof. Code Sec. 17200.)  
           In describing the unfair competition law's broad scope, the  
          Supreme Court explained "it does not proscribe specific  
          practices.  Rather . . . it defines unfair competition to  
          include any unlawful, unfair or fraudulent business act or  
          practice.  Its coverage is sweeping, embracing anything that can  
          properly be called a business practice and that at the same time  
          is forbidden by law."  (Cel-Tech Communications, Inc. v. Los  
          Angeles Cellular Telephone Co. (1999) 20 Cal.4th 163, 180  
          (internal quotation marks and citations omitted).)  Importantly,  
          the UCL's "statutory language referring to any unlawful, unfair  
          or fraudulent practice makes clear that a practice may be deemed  
          unfair even if not specifically proscribed by some other law."   
          (Id.)  "[T]he Legislature . . . intended by this sweeping  
          language to permit tribunals to enjoin on-going wrongful  
          business conduct in whatever context such activity might occur.   
          Indeed, . . . the section was intentionally framed in its broad,  
          sweeping language, precisely to enable judicial tribunals to  
          deal with the innumerable new schemes which the fertility of  
          man's invention would contrive."  (Id.)  On its face, the UCL  
          would appear to already capture the sort of dishonest business  
          practice this bill intends to prohibit.  (See Patent Trust v.  
          Microsoft Corp. (2007, SD Cal) 525 F.Supp.2d 1200 (upholding  
          defendant's fraudulent act or practice UCL counterclaim against  
          patent assertion entity).)  Similarly, to the extent a  
          non-practicing entity's more egregious "bad faith"  
          communications constitute willful efforts to deceive others with  
          an intent to induce them to alter their position to their  
          detriment, California's civil fraud statute may already provide  
          adequate relief.  (See Civ. Code Sec. 1709.)

           4.Impact to Existing Remedies  

          As noted in Comment 3, California's existing consumer protection  
          laws may already provide relief to individuals and businesses  
          harmed by "bad faith" patent assertions and demands.  While  







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          intended to provide additional relief to aggrieved parties, this  
          bill may actually harm the ability of individuals to bring  
          claims against those who assert patent claims in bad faith.

          As a threshold matter, it should be noted that while this bill  
          prohibits a detailed and extensive set of practices, the bill's  
          provisions may only be enforced by a very limited group of  
          attorneys acting on behalf of the state, including the attorney  
          general.  The Innovation Alliance, writing in support, states  
          that this bill "would allow enforcement by the state attorney  
          general only.  This will ensure the law is fairly enforced  
          against abusers, and not be used as a weapon by private parties  
          to penalize legitimate patent owners for asserting their  
          rights."  Section 3273.7(b) of the bill states "notwithstanding  
          any other law, the Attorney General or an attorney acting on  
          behalf of the state shall have the sole authority to enforce  
          this title.  This title shall not be construed to create a  
          private right of action."  This restriction on enforceability  
          significantly undercuts the bill's remedial aims.  Depending on  
          funding, staffing levels, and other enforcement priorities, the  
          attorney general and designated attorneys acting on behalf of  
          the state may be unwilling or unable to prosecute offenders and  
          enforce the practices prohibited by this bill.

          More importantly, by explicitly prohibiting these specific  
          patent assertion related acts, this bill might actually deprive  
          California residents of certain remedies available to them under  
          existing law, particularly claims based on violations of the  
          Unfair Competition Law (UCL).  The Supreme Court has held that:

            [a]lthough the unfair competition law's scope is sweeping, it  
            is not unlimited.  Courts may not simply impose their own  
            notions of the day as to what is fair or unfair.  Specific  
            legislation may limit the judiciary's power to declare conduct  
                                                                       unfair.  If the Legislature has permitted certain conduct or  
            considered a situation and concluded no action should lie,  
            courts may not override that determination. When specific  
            legislation provides a safe harbor, plaintiffs may not use the  
            general unfair competition law to assault that harbor.   
            (Cel-Tech Communications, Inc. v. Los Angeles Cellular  
            Telephone Co. (1999) 20 Cal.4th 163, 182 (internal quotation  
            marks and citations omitted).)
          This bill's limited remedies provision may be interpreted as  
          providing just this sort of legislative safe harbor.  By  
          restricting enforcement authority to the attorney general and  







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          designated attorneys acting on behalf of the state, a reviewing  
          court may be inclined to dismiss private party UCL claims based  
          on activities that also fall within the scope of this bill.  As  
          the Court has observed, "[a] plaintiff may . . . not plead  
          around an absolute bar to relief simply by recasting the cause  
          of action as one for unfair competition."  (Id.)  Explicitly  
          barring plaintiffs from maintaining a private right of action in  
          this bill may render similar UCL claims as attempts to "plead  
          around" this bill's remedies limitations, thus eliminating  
          causes of action that may be available under existing law.

           5.Federal Preemption  

          The United States Constitution grants exclusive authority to  
          Congress for the regulation of patents and copyrights.  Article  
          I, Section 8 states that Congress shall have the power "to  
          promote the progress of science and useful arts, by securing for  
          limited times to authors and inventors the exclusive right to  
          their respective writings and discoveries."  Patents are issued  
          pursuant to the federal Patent Act by the U.S. Patent and  
          Trademark Office, and the adjudication of patents is handled  
          exclusively in the federal courts.  The constitutional grant of  
          exclusive authority over patents to Congress may ultimately  
          preempt California laws designed to protect individuals and  
          businesses from bad faith patent claims and demands.

          The U.S. Supreme Court has held that the federal patent system: 

            is one in which uniform federal standards are carefully used  
            to promote invention while at the same time preserving free  
            competition.  Obviously a State could not, consistently with  
            the Supremacy Clause of the Constitution, extend the life of a  
            patent beyond its expiration date or give a patent on an  
            article which lacked the level of invention required for  
            federal patents.  To do either would run counter to the policy  
            of Congress of granting patents only to true inventions, and  
            then only for a limited time.  Just as a State cannot encroach  
            upon the federal patent laws directly, it cannot, under some  
            other law, such as that forbidding unfair competition, give  
            protection of a kind that clashes with the objectives of the  
            federal patent laws.  (Sears, Roebuck & Co. v. Stiffel Co.  
            (1964) 376 U.S. 225, 230-231.)

          While the Supreme Court has upheld certain state laws that touch  
          upon patents (see e.g. Kewanee v. Bicron (1974) 416 U.S. 470,  







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          492 (holding that patent law does not preempt trade secret  
          law)), the reach of federal preemption in this area of law is  
          unclear.  Scholars have noted that whether or not patent  
          assertion activities - such as the sending of demand letters -  
          are "legal uses of federally created patent rights or . . .  
          abusive business practices" is "[a] heated debate" and "test[s]  
          a very fine line between a patent holder's right to exclude  
          others from infringing its patents and a state's consumer  
          protection obligation."  (David Johnson, Facing Down the Trolls:  
          States Stumble on the Bridge to Patent-Assertion Regulation, 71  
          Wash & Lee L. Rev. 2023, 2025-2027.)
          This bill seeks to protect California consumers by prohibiting  
          patent assertions and claims made in "bad faith."  However, in  
          so doing, California's standard for measuring "bad faith" patent  
          claims may conflict with federal patent law's protection of a  
          patent holder's good faith assertions.  (See C.R. Bard v. M3  
          Sys. (Fed. Cir. 1998) 157 F.3d 1340, 1369 ("The law recognizes a  
          presumption that the assertion of a duly granted patent is made  
          in good faith; this presumption is overcome only by affirmative  
          evidence of bad faith.").)  Particularly where this bill  
          requires those who assert patent claims to include specific  
          information in their written communications, federal law may  
          preempt California's ability to prohibit certain patent  
          assertions and claims.

           6.Potential Chilling Effect on Patent Assertions  

          While this bill is intended to protect California businesses and  
          individuals from bad faith patent assertions and claims, certain  
          elements of the bill may, in operation, harm legitimate patent  
          holders and discourage them from asserting their rights.  First,  
          the requirement that patent holders identify in their written  
          assertions the identification of an infringed upon patent, the  
          identification of an infringing product or service, and a  
          description of how that product or service infringes upon the  
          patent, may be impossible without first going through limited  
          discovery.  Especially with technological processes and  
          electronic circuitry, a patent holder might not have enough  
          information at the claim assertion stage to provide this  
          information and avoid a counterclaim of acting in "bad faith."   
          Second, the possibility of enforcement of this bill's provisions  
          by the Attorney General or others may be used by some entities  
          to intimidate patent holders, particularly individuals and small  
          businesses, from protecting their rights by asserting claims to  
          patented products, technologies, and industrial methods.   







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          Finally, the inclusion of an affirmative defense of "good faith"  
          may be perceived as shifting the burden away from those bringing  
          claims under this bill to prove "bad faith," toward the patent  
          holder having to demonstrate that his or her claim was made in  
          "good faith."


           Support  :  California Bankers Association; California Chamber of  
          Commerce; Innovation Alliance; Qualcomm, Inc.; Silicon Valley  
          Leadership Group

           Opposition  :  None Known

                                        HISTORY
           
           Source  :  Author

           Related Pending Legislation  :  AJR 9 (Chang) would make specified  
          findings regarding patents and patent litigation, and would urge  
          the President and the Congress of the United States to craft a  
          balanced and workable approach to reduce incentives for and  
          minimize abusive and frivolous patent litigation while ensuring  
          that legitimate patent enforcement rights are protected and  
          maintained.
           Prior Legislation  :  None Known

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