Monday, May 11, 2015

Fee Shifting and Veil Piercing

One of the discussion points about the new PATENT Act reform proposal making the rounds is the "reach through" that pierces the corporate veil for those entities that must pay attorneys' fees. Like so many of these fee shifting proposals, I'm left scratching my head and wondering whether this is where we want to make our stand, heading down the slippery slope of corporate veil piercing. I can think of so many other worthy plaintiffs and defendants where I would rather pierce the veil, and yet we don't.

I don't want to minimize the concern. The protection offered limited liability companies is a real problem for those who want to collect against them. I've known this since I was shocked to read Walkovszky v. Carlton in corporations law. The defendant owned 20 taxicabs in 10 corporations, but the court allowed liability only against the one corporation that owned the cab that ran over the plaintiff. While it seems ridiculous to allow corporations to avoid liability this way, this is a deeply engrained rule of law in this country. In any event, I haven't seen any real data about how often fee awards go unpaid, so I don't know just how much of a problem this really is. I suppose it will become a more common problem if there is more fee shifting.

Make no mistake, though, the PATENT Act and all other veil-piercing fee proposals are not about under-capitalized shell companies - not at a deeper level. These proposals stand for the proposition that we hate patent enforcement by non-practicing entities so much that we're just going to throw out all the rules that apply to everyone else, no matter how bad an actor all those other people are. Only patent plaintiffs are so despicable that they are no longer entitled to corporate status.  And this is not just about patent acquisition companies - this covers inventor operated companies, research companies and think tanks, failed startups, and anyone else who doesn't make a product.

I should note here that I'm not wholly opposed to fee shifting. I think there can be some benefit to reciprocal fee shifting, and I also think that the "objectively unreasonable" standard is better than a presumption. I should also note that this is not a plaintiff only issue. Only a few short years ago, record companies sued a venture capital firm for investing in copyright defendant Napster, a company that had, at best, a crapshoot of winning its case. That investor suit was also unwarranted for the same reasons that this proposal is: targeted veil piercing to support substantive policy goals is not a great idea -- the bell tolls for thee.

After the jump is my nitty-gritty analysis of the fee-shifting and veil-piercing proposal, and discussion about why I think it's a problem.

First, I think we should be clear that this proposal is anti-enforcement plaintiff, not anti-shell or anti-undercapitalization. For example, if we are so worried about shells, why not require all plaintiffs to show that they have funds, rather than just those that are NPEs? Surely underfunded startups can file patent suits. And why not make all defendants guarantee they can pay damages or else we’ll pierce the veil? We hate shells and undercapitalized parties, right? The answer, of course, is that we only hate a shell this much if it is of a particular type, and that’s a non-practicing patent plaintiff. It's not even anti-troll, really, because under the proposal, anyone that doesn't make a product is on the hook, regardless of whether the plaintiff does the things that one would associate with a patent troll (whatever that definition is).

Whether one agrees with this rule or not, the debate should include candor about what this proposal is about.

Let's look at the specific statutory language.  Under proposed 285(c)(1)(G)(2)(A), an interested party is anyone with an interest, including employees. The exception in (G)(2)(C) makes this clear, because it excludes professors that assign all rights to a university and only get a royalty. This implies that an inventor who assigns to other companies that make no products and stand to make a royalty is an interested party. Think about that - we are no longer considering charging just investors or shell company owners with attorneys fees. Instead, the proposal would pierce the veil all the way down to the inventor that assigned the patent to his or her employer.

As I see it, the only NPE that fits the exception of having no interested parties is one that buys all patents for a flat fee and has no shareholders (e.g. operates as a nonprofit). This sounds like a university; except they are exempted and their employees are as well.

Here are the policy implications I see from this proposal:

1. Individuals will be forced to sell and assign their patents for a flat fee rather than for a percentage of income, which will be lower because the patent's value may be unknown early on. This drives down payback to inventors, which is the exact opposite of we want. In other words, Morton & Shapiro's bucket gets even leakier.

2. Employees of R&D companies that might get bonuses for patent income are now on the hook, which likely will either reduce income or reduce incentives.

3. Indeed, investment in R&D companies will go down, because the corporate veil now means nothing. 

4. Of course, current incumbents can pay their debts, but forget about new R&D companies being willing or able to enforce their patents (and thus willing to form in the first place). The message of this proposal is that we just don't care whether these companies exist, because a primary way to enforce their technology gains is the possibility of suit, which becomes worthless if one cannot actually follow through.

5. Startups that fail are also at risk, but only those investors that invest after failure (as set forth in (G)(2)(D) of the proposal). This highlights for me that this is all about dissuading patent enforcement  and nothing about shells. This is not about making sure defendants (or plaintiffs) can collect. This is about deterring lawsuits.

The message is crystal clear here: If you plan to make money on patent enforcement, whether you are an inventor, shareholder, lender, employee, or otherwise, then there is no corporate veil for you. You are simply not entitled to the protections we give every other limited liability company, no matter how scummy they are, no matter how many people they rip off, no matter how putrid their business model. You are worse; for you, we make an exception, we make it non-mutually, and we only make it if you are small.

This last point bears special note: this proposal not only discards the corporate veil, it does so in an anti-competitive way. It will surely make it difficult to enter the market. Indeed, BIO has now come out in favor of this provision because it "deters shells." As Ted Sichelman has noted, fee shifting likely just means consolidation to larger enforcement companies that can cover fees.

In sum: a) we throw out an important legal rule - selectively, no less, b) inventors get less, and c) defendants still get sued, only by more and bigger NPEs that can afford it. That doesn't sound like a great policy to me.

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