BILL ANALYSIS Ó SENATE JUDICIARY COMMITTEE Senator Hannah-Beth Jackson, Chair 2015 - 2016 Regular Session SB 681 (Hill) Version: February 27, 2015 Hearing Date: April 28, 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 SB 681 (Hill) Page 2 of ? 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.) SB 681 (Hill) Page 3 of ? 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 SB 681 (Hill) Page 4 of ? 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 SB 681 (Hill) Page 5 of ? 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 SB 681 (Hill) Page 6 of ? 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].) SB 681 (Hill) Page 7 of ? 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 SB 681 (Hill) Page 8 of ? 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 SB 681 (Hill) Page 9 of ? 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 SB 681 (Hill) Page 10 of ? 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 SB 681 (Hill) Page 11 of ? 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. The Committee may want to consider the following amendments to ensure that this bill does not deprive California residents of remedies they currently have under existing law. Suggested Amendments : On page 4, line 12, strike "Notwithstanding any other law, the" and insert "The" On page 4, following line 15, insert "(c) Nothing in this title shall be construed to impair or impede any other rights, causes of action, claims, or defenses available under other law. The remedies provided in this title are cumulative with any other remedies available under other 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 SB 681 (Hill) Page 12 of ? 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, 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 SB 681 (Hill) Page 13 of ? 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. 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." The Committee may want to consider the following amendments to ensure patent holders are able to assert their rights in good faith without exposing themselves to unwarranted liability. Suggested Amendments : On page 2, line 25, after "representations" insert "knowing they are false" On page 3, line 11, after "communication" insert "fraudulently" On page 3, line 11, strike ", in bad faith," On page 3, strike lines 20 and 21, and insert "(3) The sender of the communication fraudulently conceals or omits any of the following information from the communication, when that information is readily available to the sender at the time the communication is sent:" On page 3, strike lines 38 through 40 On page 4, strike lines 1 through 4 SB 681 (Hill) Page 14 of ? 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 **************