The Prior Art

Patent Litigation Weekly: A Closer Look at a New Patent Study

2010-02-05T14:36:30-08:00

Two years after Richard Frenkel—at the time an in-house Cisco Systems, Inc., lawyer and now of counsel at Wilson Sonsini Goodrich & Rosati—outed himself as the until-then-anonymous author of the controversial patent litigation blog, the Patent Troll Tracker saga appears to be over.

In January, a libel suit filed by East Texas lawyer T. John “Johnny” Ward, Jr. against Cisco over the contents of an October 2007 Troll Tracker post was settled under confidential terms. Frenkel—dismissed as a defendant in the case last August at Ward's request—has declined to comment on either Ward's suit or a second, related defamation claim filed against him and Cisco by East Texas lawyer Eric Albritton. (That suit settled in September after a week-long trial; see earlier coverage on The Prior Art here, here, and here.)

While it’s clear now that at least a few high-level Cisco employees knew the Troll Tracker’s identity, company lawyers say no one there besides Frenkel contributed to the blog. Still, because Cisco is helping to lead the lobbying charge in favor of reforming the nation's patent laws—with a particular focus on lowering litigation payouts to non-practicing entities (a.k.a. NPEs, or "patent trolls")—those who advocate for small patent holders sensed a Frenkel-Cisco conspiracy.

Putting aside the conspiracy theories aside and drama—two lawyers with a high profile in the Eastern District of Texas's lucrative patent litigation scene suing Cisco and one of its in-house lawyers for libel and defamation—it seems like an opportune time to take a broad look at the big issue at the heart of the Troll Tracker tale: that the huge piles of money at stake in patent litigation has created an independent class of IP professionals? As it happens, a PricewaterhouseCoopers study released in January on just that topic has some answers.

"Patent trolling" has its rewards.

Tech-sector executives and lawyers say privately—and an informed review of court dockets confirms—that so-called trolls aren't just surviving, they're thriving. The essential NPE tactic—suing a broad swath of companies for patent infringement, then settling with each defendant for less than the cost of fighting such a suit—is now an established business model. It's so solid, in fact, that patent-holders are starting to delve into previously untouched economic sectors, suing small retailers and even photographers.

One surprising statistic contained in the PwC study that supports this: since 2002, NPEs have consistently won larger damage awards than operating companies. That suggests NPE lawyers are learning new techniques for maximizing payouts, says one of the study's authors, forensic accountant Chris Barry.

Patent suits are rarely tied to marketplace competition.

PwC looked at more than 1,400 patent cases that resulted in a decision by either a judge or jury. Depending on the district, NPEs brought between 15 and 46 percent of such cases. The district with the highest rate of NPE litigation might surprise you: Washington, D.C. where 46 percent of verdicts came in cases brought by NPEs.

Also worth noting: A chart included in the study shows that NPEs won four of the top ten patent judgments reached between 2005 and 2008. But that doesn't tell the whole story.

Under a broader definition of what constitutes "NPE-style litigation"—one that draws a distinction between suits brought by actual competitors and those brought be patent-holders in search of royalty payments but either uninterested or incapable of competing in the market—the number rises to seven out of the top ten judgments.

(Two of the ten judgments went to Alcatel-Lucent as a result of suits brought against Microsoft. While Alcatel-Lucent can certainly be considered an operating company in general, in the context of the Microsoft litigation, it was not in competition with the software giant, but simply trying to monetize the patent portfolio it had inherited from Bell Laboratories. A third "operating company," Freedom Wireless, is tiny. While Freedom has profited handsomely from its many patent suits against international phone carriers, it's unlikely that it could seriously compete against any of those larger companies.)

That leaves just three of the ten largest patent litigation awards handed out between 2005 and 2008 going to patent-holders that compete with their alleged infringers. (Interestingly, those suits between real rivals all involved patents on medical devices.)

So what's going on here? It's possible that a split is emerging, with a small, select group of industries—including medical device, pharmaceutical, and chemical companies—using patents as tools to fight over market share, while across a broader swath of the economy, patents are used mainly (or even solely) to generate revenue for those who hold them. Falling into the latter category are classic "patent trolls," but also research universities and big companies with standalone patent-licensing operations.

Transparency is still lacking.

Historically, it's been extremely difficult to uncover even basic facts about patent plaintiffs lining up for their day in court. How difficult? It took "several hundred man hours" for PWC to put together its study, Barry says. And with many plaintiffs suing via shell companies, patent litigation can look less like inventors demanding just rewards, and more like shady operators seeking an easy payday.

Most people believe true innovators deserve compensation, and understand that patents can help them get it. But to a lot of tech industry insiders who learned the details of patent litigation by reading the Patent Troll Tracker, the system looked broken, if not corrupt.

Notes on other data contained in the PwC study:

•NPEs don't fare well on summary judgment, but do just fine at trial, where they and operating companies both win two out of every three verdicts. Still, because of their poor performance on summary judgment, NPEs have an overall "win rate" of just 29 percent, compared to 41 percent for operating companies.

•In general, alleged infringers fare best when they preemptively seek declaratory judgments against patent holders (in other words, when they shoot first and ask questions later).

•Certain federal district courts (particularly the eastern districts of Texas and Virginia) continue to be more favorable to patent-holders, with shorter times-to-trial, higher success rates, and higher median damages awards.

•Five federal district courts accounted for one out of every three identified decisions involving an NPE as the patent holder: the Northern District of California, Delaware, the Northern District of Illinois, the Southern District of New York, and, of course, the Eastern District of Texas.

See the full PwC patent litigation report.

Image via Wikimedia

Patent Litigation Weekly: Shutter Closing on Massive Photo-Sharing Patent Suit

2010-01-20T16:58:15-08:00

FotoMedia is a patent-holding company that claims just about every photo-sharing website you can imagine infringes its three patents. Its lawsuits, covered by TPA last May and June, are notable not just for the audacity of the claims they make, but also because they target dozens of small- and medium-sized software companies that provide various types of photo-sharing services over the Internet.

In previous stories about the FotoMedia suits, TPA detailed the litigation’s effect on San Francisco-based Fotki.com, which has about 25 employees, and the three-man, Texas-based software company FotoTime.

As the new year starts, some of the FotoMedia defendants are breathing a sigh of relief—and the rest may be doing the same soon. That's because reexamination requests filed with the United States Patent and Trademark Office by Yahoo Inc. appear to have knocked out nearly all the patent claims at issue. FotoMedia's lawyers at McKool Smith have reacted to that development by offering to either stay the suits or have them dismissed without prejudice (leaving FotoMedia able refile the claims at a later date.)

In court filings, Fotomedia says it wants to conserve judicial resources while continuing to contest the reexam results. It’s a bit surprising, since one of the traditional attractions of filing suit in the Eastern District of Texas is that judges tend not to stay litigation just because re-examinations are underway. (And as those reexams can indeed drag on.)

But at least two defendants named in one of the four FotoMedia suits aren’t in any hurry to drop the litigation at this point—Zazzle.com, and Scripps Networks (which owns Food Network and a few other cable channels). In court papers, Scripps' lawyers note that they've already spent considerable time and money trying to fend off FotoMedia’s claims. Now, they want the chance to invalidate the patents instead of leaving open the possibility of being dragged back to court.

The reexam results represent a significant setback for McKool Smith. Perhaps more than any other law firm, the Dallas-based McKool showed in 2009 that the Eastern District of Texas is still a go-to venue for wringing big verdicts out of technology companies: a recent press release shows the firm is responsible for some of the year's biggest verdicts.

McKool's promotional material doesn’t emphasize its work for FotoMedia, a patent-holding company whose only apparent business is filing infringement lawsuits. As part of its litigation campaign, FotoMedia has been demanding royalty payments from more than 60 companies with photo-sharing websites. The McKool lawyer in charge of the FotoMedia cases was not available for interviews on Friday, and FotoMedia has not responded to TPA interview requests in the past. FotoMedia is also represented by Ward & Olivo, a firm out of New York that frequently represents patent-holding companies.

(See the TPA reference page on FotoMedia for more details about the patents, companies, and law firms involved.)

Among those breathing easier thanks to the reexam results is Chris MacAskill. MacAskill is co-founder of SmugMug, the family business he runs with about 25 employees—nine of them MacAskills—in Mountain View, California. He said he feels like a black cloud has been lifted from over the company.

"It's an enormous relief for us," MacAskill said. "It just means we have more money to develop features and advance our technology, as opposed to spending it on lawsuits."

In the end, SmugMug hasn’t had to spend a fortune in legal fees, mainly because Yahoo took the lead with an aggressive defense, filing for ex-parte reexaminations on all three of FotoMedia’s asserted patents. (It's not clear if Yahoo will fully reap the benefits of the favorable reexam results; the company reached a settlement with FotoMedia in August.)

MacAskill founded SmugMug with his son Don in 2002. Like other photo-sharing entrepreneurs targeted by FotoMedia who TPA has interviewed, MacAskill didn't think to get patents for his business because it didn't seem to involve anything new enough to be patentable—just a better execution of existing technology (combined, he ways, with scrupulous customer service).

During the first four years SmugMug was in business, nobody bothered the company about patents. But in the past three years, MacAskill has been hit with patent threats from no less than seven different parties—only one of whom is an actual competitor. FotoMedia is one of three patent-holders to actually file suit against SmugMug between 2007 and 2009.

MacAskill said the suits have changed the way SmugMug does business--and not for the better.

"Every time we write an e-mail now,” he said, “we have to ask ourselves, if discovery happened here and this e-mail gets read in front of a jury, what are they going to think? It's amazing how much that slows down and hampers doing business.”

Even if MacAskill had hired someone to do a search to find patents relevant to the business he was launching, it’s unlikely he would have identified the ones that have been wielded against him. For example, patent number 7,032,030, which is owned by holding company Easyweb, relates to receiving information by fax or audio and converting it into a Web page.

"I can't believe they would see that patent and say, that would somehow apply to Smugmug," MacAskill said. Still, he felt compelled to reach a settlement with Easyweb rather than face the high cost of discovery, which could easily have run into the mid-six figures.

"I can start a whole company with $500,000," notes MacAskill. "I can pay a handful of engineers and do a great website... but when it comes to defending against a lawsuit on a 'digital postcard' patent, it's not enough."

Igor Shoifot, CEO of Fotki.com, is another FotoMedia target who is elated to hear that the lawsuit against his compay seems to have ground to a halt—at least for now. When TPA first interviewed Shoifot, he was contemplating leaving the country as a result of all the patent litigation he faced.

"I feel relieved," said Shoifot. "But I wouldn't say that I feel that the system really worked. It was our luck that the trolls were going after not just us, but after some big guys. And when you go after big guys, they can shoot back... But one thing is for sure, we're no longer thinking about moving to Canada.”

Photo via Wikimedia

Patent Litigation Weekly: So What Do E.D. Texas Jurors Really Think?

2010-01-11T10:18:34-08:00

This week: The Prior Art returns after its winter blogging break. As Microsoft gets set to scrap software found to infringe a Canadian company's software, The Prior Art discusses the case with three of the eight jurors whose verdict helped put the software giant in this predicament.

As of Monday—thanks to a permanent injunction issued in August by Judge Leonard Davis of the Eastern District of Texas and upheld last month by the Federal Circuit Court of Appeals—Microsoft Inc. must stop selling any version of Microsoft Word 2007 or Microsoft Office 2007 that includes a custom XML editor found to infringe a patent held by a small Canadian software company called i4i, Inc.

It’s not every day that such a well-known product has to be modified—or possibly removed from store shelves—because of a patent dispute. Indeed, the U.S. Supreme Court made getting such an injunction in a patent case extremely difficult with its landmark eBay v. MercExchange ruling in 2006.

Microsoft isn’t giving up the court fight over the patent at issue just yet. On Friday, the company’s legal team, led by Matthew Powers of Weil, Gotshal & Manges, filed a petition with the Federal Circuit asking for a rehearing en banc. Powers didn't return calls for this story. Earlier coverage on i4i's trial win, post-trial action, and Federal Circuit win is available from the AmLaw Litigation Daily.

Regardless of whether that petition is accepted, Microsoft spokesman Kevin Kutz said in a statement that the company will comply with the injunction: "We have been preparing for this possibility since the District Court issued its injunction in August 2009 and have put the wheels in motion to remove this little-used feature from these products."

Microsoft no doubt wants to downplay the matter, but the simple fact of the injunction adds significance to the case beyond the hefty $290 million in damages the company must pay i4i (the figure includes $200 million awarded by the jury that that heard the case, plus $90 million in enhanced damages, post-verdict damages and interest tacked on by Davis).

As the legal machinations continue, The Prior Art decided to check in with some of the jurors who heard the case, hoping to glean some insight into how they resolved a major patent dispute in a popular venue widely considered to be extremely plaintiff-friendly. TPA was able to contact three of the eight jurors on the case.

The first juror we caught up with was Barbara Greer, a school counselor who served as the forewoman. Greer says she had no doubt about how she would vote once testimony wrapped up.

“I felt that i4i had a really strong case,” she says. “It was evident that Microsoft knew that [i4i] had a patent," and still decided “all of a sudden” to create its own version. “It just didn't sound believable from the Microsoft side.”

Greer was surprised that the software giant wasn’t able to make a stronger argument: “I expected Microsoft to have done a better job in proving their case, I guess, just because it's a big company.”

As far as Microsoft’s claim that the i4i patent at issue should be invalidated, Greer says she didn’t buy that argument: “I really felt like with experts in the patent office…they knew what they were doing. I suppose I really have a lot of confidence in the U.S. patent office.”

After the trial ended, Judge Davis spent some time talking with the jurors, several of whom, Greer says, had the same question: “We were wondering how such a big case ended up in Tyler.” Davis, she says, “said that usually things come through a lot faster in East Texas than in some other federal courts, so companies sometimes come here to get their cases heard.”

A second juror, electrician Jarrett Stephenson, says he was struck that Microsoft’s lone witness was a software engineer, unlike i4i, whose founder, Michael Vulpe, testified. “I think a lot of the jurors, we all thought if this was that big a deal to Microsoft, they might have had some of their more executive-type people present."

In describing his take on the case, Stephenson strikes something of a populist tone. “It's the same thing going on with America these days. It's big business. They just don't care. Two hundred million dollars seems to me like a great amount of money…I would think if I was Bill Gates, and had $200 million on the line, I would want to be present.”

Testimony during the trial revealed that i4i and Microsoft representatives met at one point to discuss Microsoft’s interest in i4i's software, a type of XML editor that could be used in conjunction with Microsoft Word. Stephenson says that was an important factor in helping him reach his decision. "[Microsoft] got their foot in the door and got enough information, and then took it.”

Of the lawyers who tried the case—Powers for Microsoft and Douglas Cawley of McKool Smith for i4i—Stephenson says they “both seemed really intelligent.” But, he says, the jury found Cawley “much more genuine and sincere.” Powers, Stephenson says, “came across as being cocky, and kind of always on the defensive about everything. He made several low blows and comments about i4i's lawyer and Michael Vulpe. That was frowned upon by the jurors.“

After the trial, Stephenson also recalled how he and others asked Davis why such a big technology lawsuit was being heard in Tyler: "He told us, in federal courts, it's kind of like other parts of the country are known for particular types of cases. Tyler’s known for patent infringement cases.”

Betsy Cook, a customer service representative, also says she was sure which party prevailed in court. “It was very plain and very clear, throughout the testimony that what Microsoft said and did wasn't right,” Cook says. “It felt like they thought they were bigger than the law.”

Like Stephenson, Cook says one thing that tipped the scales in i4i’s favor was the testimony about a meeting between representatives of the two companies to discuss Microsoft’s interest in i4i’s software.

“At the meeting, when [i4i] actually showed [the XML software] to [Microsoft] …Microsoft was very excited about it.” Then, she says, Microsoft “started figuring out what it was and started using it.”

Once the trial ended, Cook went online and read up on what others were saying about the case she’d just sat on, and it wasn't all pleasant. “They talked about stupid people in Texas, ignorant people in Texas, on a lot of the blogs,” she says. "They talked about how patent companies were coming to Texas because there were dumb people on the juries.”

But those people didn't hear the testimony in the case.

"If you sat through that trial at all, you would know, it was just so clear cut. They weren't there. They didn't know. If they had heard what I heard, they could not have come up with any other verdict.” None of the eight jurors was even slightly inclined to find for Microsoft, says Cook.

“I wanted Microsoft to be right,” she says. "Microsoft employs a lot of people. I didn't want a Canadian company to come here and take our money. There were a lot of reasons I didn't want it to be that way.”

The only matter of debate once deliberations began, Cook says, was the size of the award. “We went lower than what I wanted to.” In her opinion, Microsoft displayed “blatant disregard [for] the other company” that left her feeling “a statement needed to be made.”

As for the $200 million verdict (to which Davis added an additional $90 million in damages), Cook says that it's hard to know how much an award like that really means in context: “We've never seen that, never will see it.”

Echoing the sentiments of other jurors, Cook says the technical nature of the case made her nervous, at first, about serving.

"I felt very incapable," she says. "I did not think it would be possible for me to be on a jury like that. But when we got through with it, I felt very confident we had done the right thing."

At the same time, she adds, “I know a whole lot more about patents than I ever wanted to. And a whole lot more about Microsoft Word than I ever wanted to know."

Many other documents on the case are available on the the website of i4i LP, the partnership organized to prosecute the infringement case for its patent, which is U.S. Patent No. 5,787,449.

Photo via Wikimedia

Bilski v. Kappos Oral Arguments: Supreme Skepticism Toward Method Patents

2009-11-10T11:09:00-08:00

For the first time in almost 30 years, the U.S. Supreme Court on Monday considered the issue of what types of technology should be eligible for patent protection when it heard oral arguments in Bilski v. Kappos.

Across the board, the justices indicated a deep skepticism toward the invention described in the patent application at issue, which was rejected by the U.S. Patent and Trademark Office and describes a method for trading commodities. Some of the justices went even further—expressing both a fair amount of disdain for the idea of granting broad "method" patents and a concern that ruling in favor of the petitioners would lead to patent grants on fundamental ways of conducting business or organizing human behavior. (Click here for a related story by sibling publication The National Law Journal Supreme Court correspondent Tony Mauro.)

Based on the justices' attitude during the arguments, it not only seems extremely unlikely that Bernard Bilski will ever get the patent at issue, it also seems clear that the court is poised to establish a new, and most likely stricter, test of what is patent eligible.

One after another, the justices prodded Bilski's lawyer, Michael Jakes of Finnegan Henderson, Farabow, Garrett & Dunner, in search of some idea about where to draw the line. The thrust of the questions: Does absolutely everything fall within the domain of the U.S. patent system?

"So, an estate plan?" asked Justice Ruth Bader Ginsburg. "A tax avoidance method? How to resist a corporate takeover? All of these are patentable?"

"They are eligible for patenting under section 101," replied Jakes, referring to the section of the 1952 patent statute that governs what is patent-eligible subject matter.

Justice Stephen Breyer was among the most vocal justices during the argument—and perhaps the most skeptical of Jakes's wide-ranging claims.

"Your argument is that anything that helps business succeed is patentable," Breyer said. Would the framers of the Constitution, he asked, really have wanted everyone with a new idea to run to Washington to get a patent, in the process enabling them to "stop the wheels of progress" unless competitors got permission?

"Why not patent a method of speed dating?" Justice Sonia Sotomayor asked.

There are a few, limited areas, Jakes said, where patent protection isn't available; he pointed to the fine arts as one example. Otherwise, he argued, patents encourage people to innovate, and it is via the patent system that they disclose their new creations to the public.

Chief Justice John Roberts directly attacked the Bilski patent, reading part of claim one aloud and asking: "How is that not an abstract idea? It's a series of transactions." The chief justice then posited his own idea for a business-method patent: "I buy low and sell high—that's my patent for maximizing wealth," said Roberts. "I don't see how that's different from your claim number one," he added, referring to the central claim in the Bilski patent, which supposedly covers a method for trading energy that hedges weather-related risk.

Justice Sotomayor took issue with Jakes's suggestion that patents are always a manifestation of innovation.

"A patent limits the free flow of information," she said. "It requires licensing. You can't argue your position is enhancing the free flow of information."

Jakes replied: "It does, because of the disclosure requirement."

"Even though the public can't use [the patented invention]," noted Scalia.

"That's our system," said Jakes. "We do grant exclusive rights in exchange for disclosure."

Time and again, Jakes refused to draw a line that ruled anything off-limits to the patent regime. His position left the justices questioning whether he was advocating the "ownership" of basic human activities.

"Let's take training horses," said Justice Antonin Scalia. "Don't you think that some people, horse whisperers or others, had some ... insights into the best way to train horses? Why didn't anybody patent those things?"

"I think our economy was based on industrial processes," responded Jakes.

"It was based on horses, for Pete's sake!" said Scalia. "I would really have thought somebody would have patented that."

Jakes argued that the the "machine-or-transformation" test adopted by the Court of Appeals for the Federal Circuit in its Bilski decision, which requires that a process patent must either be tied to a particular machine or must transform something into another state in order to be patent-eligible, was a rigid, narrow test that would preclude a wide range of new technologies from enjoying patent protection.

The machine-or-transformation test, Jakes said, "would exclude some valuable inventions that I think everyone would agree are technological under any test, such as data compression, such as FM radio."

Justice Anthony Kennedy and Chief Justice Roberts then asked about what part of the Morse code—arguably an alphabet transformed into electric signals—would be patentable under this test.

"You think you can patent an alphabet because it is a process of forming words," said Chief Justice Roberts.

"It could be, yes," Jakes answered. But, he added, applicants for such a patent would have to prove their tests were, among other things, novel and non-obvious.

Deputy Solicitor General Malcolm Stewart, meanwhile, argued in defense of the "machine-or-transformation" test. The justices pressed him for some idea about what kind of test might be more useful.

Stewart made clear the government was looking for a way to kick out "pure" business method patents such as the Bilski claims. "Innovations as to new techniques of public speaking, new techniques of negotiation... they may be valuable. They may be innovative. They are not patent eligible because they don't deal in the realm of the physical."

At the same time, Stewart didn't express support for rolling back patentability in a way that would threaten software patents or coming out in favor of a blanket ban on "business-method" patents. Such a ban could be seen as eliminating certain types of patents tied to machines, he said. And Stewart said the Federal Circuit's test wasn't "rigid or inflexible," as his opponent had argued.

Chief Justice Roberts pushed back on an inconsistency in Stewart's briefing of the case. On the one hand, he said, the government claims Bilski's method just describes a way of doing business, and therefore isn't patentable—but then posits that a computer with an "interactive website" doing the same thing might be. "That's like saying if you use a typewriter to type out the process, then it's patentable," said Roberts.

If the website scheme was part of a computer program, Stewart said, "the computer would be at the heart of the innovation."

"No, no," said Roberts. "That's just saying instead of looking in the Yellow Pages, you look on a computer."

Stewart urged the court not to use the Bilski case as a vehicle for determining what kind of patents are allowed in important technology sectors like software and medical-diagnostic technology. He also made clear that the government isn't seeking a reversal of the State Street Bank and Trust, which is generally seen as the Federal Circuit case that opened the door to the widespread patenting of software. (Several of the more than 70 amicus briefs filed in the Bilski case asked the court to take a clear position on software patents—some in favor, others against.)

Stewart acknowledged that the Federal Circuit's Bilski opinion "didn't answer all of the hard questions," such as the precise level of machine involvement needed to pass the test.

Justice Breyer agreed, saying the Federal Circuit had left "much unresolved."

After the arguments concluded, Michael Jakes answered a barrage of reporters' questions about the court's apparently hostile attitude towards the Bilski patent application specifically and business method patents generally.

Standing on the plaza outside the court, Jakes put on a confident face, noting that the Supreme Court "has said rigid and inflexible tests are not the way to go. We want the patent system to be open to all methods."

Then reporters were also treated to an appearance by inventor Rand Warsaw, who described the fixed-billing method offered by his company, WeatherWise. Warsaw was followed by an appearance by the elusive Bilski himself, who hasn't spoken publicly about his high-profile case before.

"I was completely awed and impressed by the whole process," Bilski said. "I couldn't tell you what the outcome will be. But not getting this patent made it very difficult to get this service out to many customers."

When reporters asked Bilski, who departed from WeatherWise in 2003, what his occupation is today, he responded, "At present I'm an employee of the federal government." In what capacity? "Not in the patent office," he said with a smile. And with that, he walked away.

Cross-posted at IPLB.com.

Patent Litigation Weekly: How to win $25 million in a patent suit—and end up with a whole lot less

2009-11-02T12:32:06-08:00

This week: DeepNines collected $25 million when it won an infringement suit against anti-virus software giant McAfee Inc. in the Eastern District of Texas two years ago. But after paying off its Fish & Richardson lawyers and outside investors at Altitude Capital Partners, the small network-security company wound up with less than $800,000 of the $25 million. And now DeepNines is being sued by Altitude, which wants millions more than it's already gotten. A revealing look at how a leading player in the lawsuit-investment trade does business.

Third-party financing of lawsuits—often described as a new and growing phenomenon—has been much in the news lately. But outside investors have been making multimillion dollar bets on patent lawsuits for years. One of the field's leading players is Altitude Capital Partners, founded by investment bankers Robert Kramer and Warren Hurwitz. Altitude, which has been investing in patent lawsuits since at least 2006, boasts of having more than $250 million to spend on such litigation.

Last week, The Prior Art reported on one patent-holding company Altitude has invested in. This week, we offer the story of another Altitude investment—one that resulted in an acrimonious lawsuit between parties that used to be on the same side.

In 2007, Altitude loaned DeepNines Inc. $8 million to pursue a patent infringement claim against leading anti-virus software maker McAfee in the Eastern District of Texas. The case went to trial and DeepNines, a small, Texas-based network-security company, won an $18 million jury verdict. Facing additional potential exposure, McAfee eventually agreed to end the litigation by paying DeepNines what at the time was a confidential settlement, but what documents now show was $25 million.

That settlement allowed DeepNines to repay the Altitude loan, plus 10 percent interest, plus another $700,000 in "participation" cash—Altitude's contingent fee winnings.

But Altitude founder Kramer wasn't satisfied with that amount. In 2008, he told DeepNines it owed Altitude some $5 million more. When he didn't get paid, Kramer hired Akin Gump Strauss Hauer & Feld to sue DeepNines in New York state Supreme Court. Most of the key documents in the case—including the heavily redacted public complaint [PDF]—were filed under seal. But this week, TPA acquired unredacted versions of many of those key documents. Taken together, they provide an intriguing peek into the workings of Altitude's patent litigation-loan business.

Among the highlights:

The parties on the plaintiffs' side in the McAfee litigation anticipated a much bigger payday than they got. Agreements between DeepNines, Altitude, and Fish & Richardson lawyers show an "estimated damages model" that posited a $200 million win. Such a victory would have translated into more than $50 million for Altitude and more than $100 million for DeepNines.
Instead, after paying its Fish & Richardson lawyers and repaying Altitude, DeepNines walked away with less than $800,000 of the $25 million.
In total, Fish & Richardson collected more than $11 million for handling the litigation: $4.07 million in hourly legal fees, $3.25 million thanks to a 13 percent contingent stake in the case, and an additional $1.9 million (It is unclear from the court papers what the latter amount was for). The balance went to DeepNines in October 2008. Two months later, company president Daniel Jackson wrote in court papers that he "questioned many of the [firm's] charges" and specifically disputed the $1.9 million took above and beyond its hourly and contingent fees. Contacted this week, lead Fish & Richardson partner Tom Melsheimer declined to comment except to say the firm has "no current disputes" with DeepNines.
Well-known former federal judge Robert Parker of Parker, Bunt & Ainsworth of Tyler, Texas, served as local counsel in the case. Parker had a 5 percent contingency stake in the matter, which netted him roughly $1.25 million. (The figure pales in comparison to the $10 million that Parker—who, according to Stanford University's LexMachina database, has been listed on the docket in more than 100 East Texas cases since 2005—stood to make under the "estimated damages model.")
DeepNines' "out of pocket" legal expenses for the case, including payments to experts and travel expenses, totaled more than $2.1 million.
The patent lawsuit represented a major gamble for DeepNines, which had less than 40 employees and just $8.4 million in assets in 2006. Only about $1 million of that amount was cash in the bank.

The saga began in 2006 when DeepNines sued McAfee for patent infringement. At issue: patent No. 7,058,976, which deals with network security technology. Soon after filing suit, DeepNines borrowed the $8 million from Altitude. The lawsuit paid off when McAfee lost the jury trial and was hit with the $18 million verdict for willful infringement.

Facing additional damages connected to the willfulness and a false marking claim, McAfee ultimately ended the dispute by agreeing after trial to pay DeepNines a settlement that the documents unearthed by TPA reveal to be $25 million. For its trouble, DeepNines walked away with less than 5 percent of that sum.

Though Altitude received $10.1 million on its original $8 million investment, CEO Kramer wrote to DeepNines in October 2008 demanding another $5.3 million, arguing that DeepNines shouldn't have deducted legal expenses before giving Altitude its contingent-fee share. The next month, Altitude hired Akin Gump to sue DeepNines for breach of contract. (The named party in that suit is Altitude Nines, an Altitude Capital subsidiary set up for the DeepNines deal.)

Aware that DeepNines has two new patents suits pending—and worried that it would plow whatever cash it has into those suits—Altitude's lawyers asked the judge in the breach-of-contract case to force DeepNines to set aside several million dollars so that the company's funds wouldn't be "dissipated." DeepNines responded by saying Altitude was unlikely to succeed in the suit, was using bogus math to calculate its fair share of the McAfee winnings, and shouldn't be awarded a preliminary injunction. DeepNines also noted that a second investor in the McAfee suit, venture capital firm Dawntreader Ventures, agreed with DeepNines' calculation even though it stood to gain if it went along with Altitude's calculations.

Ultimately, Justice Richard Lowe ruled that Altitude's lawsuit was a "garden variety" breach of contract case that didn't require an injunction.

Neither Altitude founder Kramer nor DeepNines' Jackson responded to phone calls and e-mails requesting comment this week. Court papers indicate that both were both scheduled to be deposed last month. DeepNines is being defended by Mintz, Levin, Cohn, Ferris, Globsky and Popeo.

This fee dispute aside, Altitude's litigation investments have been getting more ambitious. In January, TPA reported that Saxon Innovations, a patent-holding company set up by Altitude, filed suit against five cell phone manufacturers at the International Trade Commission, seeking to bar imports of several popular phone models into the United States. That's a high-stakes undertaking, because litigating a case at the ITC can cost $10 million or more.

Meanwhile, e-mails between DeepNines' Jackson and his outside investors that are included in the breach-of-contract case documents show reveal frustration with Fish's performance in the McAfee case—and with the firm's bill: "The fact that we ended up with less than expected is because they screwed up the claim construction," wrote Ed Sim of Dawntreader Ventures in one e-mail to Jackson and other investors. Sim also suggested that in the future, DeepNines hire its lawyers on a full contingency basis.

Apparently Fulbright & Jaworski fit the bill. DeepNines has hired the Texas firm for its two pending patent lawsuits: a second one against McAfee filed in May that accuses the software maker of infringing two other DeepNines patents, as well as the '976 patent again, and a suit filed last month asserting two patents against Fortinet, Inc.

Altitude Nines, LLC v. Deep Nines, Inc. 603268-2008, Supreme Court, County of New York.

Documents:

Spreadsheet showing DeepNines' and Altitude's differing calculations of "IP Revenue" [PDF]
Declaration of DeepNines President Daniel Jackson [PDF]
Declaration of Altitude Capital founder Robert Kramer [PDF]

Image: Wikimedia / FML