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Better to be Good than Lucky: Using Fantasy Sports Strategy to Defend the Legal Status of America’s Newest Pastime

By Erica Buerger

I. Introduction

When Indianapolis Colts’ future Hall of Fame quarterback Peyton Manning announced that he would not start the 2011 NFL season, his streak of 227 consecutive starts ended and fantasy team owners panicked.  In 2011, there were approximately $650 million of fantasy football prizes on the line.[1]  It is estimated that Manning’s absence shifted $65 million away from people who would have won their fantasy football leagues had he not been injured.

There are currently over 32 million fantasy sports players in the United States and Canada, and the industry generates more than $3 billion in revenue.[2]  Fantasy sports have become as much of an American pastime as the games upon which they are based.  But this popularity may be disguising the fact that fantasy sports are just another form of illegal gambling.  In most states, the legality of a betting game depends upon the amount of skill versus chance required to play the game.  In general, the more skill that is involved, the more likely the game is legal.

The problem is that as fantasy sports evolve to meet the needs of an ever-expanding fan base, many leagues have added features that allow less-knowledgeable players to participate.  By lowering the amount of skill needed to play, the outcome is more chance-based.  If this trend continues and current gambling law prevails, fantasy sports could become so dependent on chance that they will become illegal.

II. Gambling Law

A. Federal Law

The purpose of federal gambling law is to “aid the states in controlling gambling.”[3]  Specifically, to assist the states in the “enforcement of their [gambling] laws.”[4]  Federal gambling laws do not attempt to create uniformity between the states.  Rather, they exist simply to supplement each state’s own laws.

B. State Law

Gambling regulation is mostly a function of state law and can vary considerably.  The dictionary defines gambling as “play[ing] a game for money or property” or “bet[ting] on an uncertain outcome.”[5]  However, most states allow activities that seem to fall into this category, such as state lotteries.  In fact, in most states, an activity is legal unless a plaintiff makes an affirmative showing that a particular activity involves three elements: consideration, reward, and chance.[6]

1. Consideration

Consideration is often loosely defined as something given in exchange for something else.  In the context of gambling, most courts construe this term narrowly holding that consideration exists only when a “participant provided money or a valuable item of property in exchange for the chance of greater winnings.”[7]  However, some courts adopt a broader definition finding that consideration exists when any legal detriment is given in exchange for the chance to win a prize.[8]

2. Reward

In gambling, the reward is the prize that one receives after winning a game of chance.  To meet this requirement, courts have held only that the reward must be tangible.[9]

3. Chance

Chance is the most controversial element.  To constitute a game of chance, courts have held that the outcome of the game must depend upon factors that are out of a player’s control, as opposed to a player’s “judgment, practice, skill, or adroitness.”[10]  To make this determination, courts have applied three tests: (1) the “dominant factor test,” (2) the “any chance test,” and (3) the “gambler’s instinct test.”

Most states use the dominant factor test.[11]  In Johnson v. Collins Entertainment, the South Carolina court explained that a game is chance-based when “the dominant factor in a participant’s success . . . is beyond his control . . . even though the participant exercises some degree of skill.”[12]  The threshold of the dominant fact test is the point at which either skill or chance affects the outcome by more than 50%.

Some states use the any chance test.  In these states, an activity is a game of chance if it incorporates any element of chance, regardless of whether the game also incorporates skill.[13]  Because almost every game involves some chance, most games will not survive scrutiny in these states.

Finally, a few states use the gambler’s instinct test.  This test defines a game of chance as one that appeals to the “gambling spirit,” without regard to whether skill or chance dictates the outcome.[14]  Because of the highly subjective nature of this test, a court’s decision can vary considerably.

III. The Legality of Fantasy Sports Under the Majority View

Most states adopt a narrow definition of consideration and use the dominant factor test.  In these states, the structure and features of a particular fantasy game is of utmost importance.  Legal fantasy games generally fall into three categories: (1) leagues that do not charge an entry fee; (2) leagues that do not award prizes; and (3) leagues that are predominately skill-based.  The first two categories are relatively straightforward.  Leagues that are free are legal because there is no consideration.  Alternatively, leagues that do not award prizes are legal because there is no reward.

The third category is more complex.  In this category, fantasy games are legal if the outcome is more than 50% based on skill.  Fantasy leagues are generally considered skill-based if they allocate players through a traditional auction and span at least one entire season.[15]  This is because fantasy players have the opportunity to offset chance occurrences, such as player injuries or adverse weather conditions, with efficient team management, lineup changes, and trade negotiation.  It is this category of fantasy games that is most at risk as the popularity of fantasy sports increases.

IV. The Future of Fantasy Sports: How New Features Affect the Dominant Factor Test

A. Auto-Draft

Auto-draft is a feature used during a fantasy draft that ensures a fantasy team owner automatically drafts the highest-rated player available.  Automatic drafting algorithms are designed to create competitive leagues.  Beginners typically use auto-draft because they lack enough knowledge to fill their teams.  Some argue that auto-draft is unfair because there is no guarantee that the owner using auto-draft would have actually selected the highest ranked player.[16]

B. Point Projections

Point projections are similar to a cheat sheet in that they predict how many points a player will earn during a game.  To set a lineup, an owner starts the players on his team with the highest number of projected points.  Point projections place a passive team owner in the same position as an owner who has done extensive research on his players’ current matchups, injury reports, or other conditions affecting a player’s potential performance.

C. Short Season Leagues

Fantasy games that stretch over longer time spans allow an owner’s managerial skills regarding drafting a team, setting lineups, and making trades to counteract the effects of chance.  Fantasy leagues that span multiple seasons allow owners to employ strategies that may take several years.  These leagues require a considerable level of commitment, knowledge, and skill.  Conversely, some leagueslast only a day or a week.  In these games, the outcome is more chance-based because it is closely tied to a single, real-world event.

D. The Effect

The intent of auto-draft, point projections, and short season games is to increase fantasy sports participation.  These features accomplish this task by reducing the need to spend time analyzing statistics and setting lineups.  But because the legality of a fantasy sports game is based on the level of skill required to play the game, these features, while increasing participation, are simultaneously pushing a multi-billion dollar industry to the brink of extinction.  To avoid this outcome, current gambling laws should not be used to regulate fantasy sports.

V. How Fantasy Sports Differ From Other Gambling Games

Fantasy sports cannot be regulated effectively under current gambling law because they are different from other casino-type games.  Fantasy sports are different because strategy can be used to overcome the chance elements involved in the game.  To understand the impact of strategy in fantasy sports games, it is important to understand the differences between strategy and skill.

Skill is “the ability to use one’s knowledge effectively.”[17]  Skill can be obtained through study, repetition, drill or practice. Often, exercising skill becomes an automatic response that occurs independently of any cognitive process.  Strategy, on the other hand, is a deliberate, planned, and conscious activity.   Strategy involves the application of skill but it also implies an understanding of the interaction between underlying concepts.

Managing a fantasy sports team takes skill and strategy.  Drafting players, for example, is partly skilled-based because players’ statistics can be learned through study.  Drafting players is also strategy-based because an owner must prioritize his selections by anticipating other owners’ choices.  Trade negotiation, however, is primarily strategy-based.  Skill-based trades would involve analyzing statistics to make mutually beneficial trades.  But most trades are not mutually beneficial.  Instead, trades typically involve psychological warfare, feeding off other owner’s impulsive natures, or exploiting other teams’ weaknesses.  In fact, many fantasy experts insist that trade negotiation is an art.

By utilizing strategy, owners can prevent chance from determining the outcome of the game.  All fantasy sports involve chance due to adverse weather conditions and possible player injuries.  However, a skillful owner circumvents these elements by drafting backup players, checking game day weather and injury reports, and adjusting his lineup as necessary.  Conversely, a poker player cannot eliminate the chance that he will be dealt an unfavorable hand, a craps player cannot anticipate the roll of the dice, and a roulette player cannot predict the number on which the ball will fall.  Therefore, the ability to use strategy to “beat chance” distinguishes fantasy sports games from other illegal gambling.

VI. Resolving Fantasy Sports’ Differences Under the Law

A. Ambiguity

Not only are fantasy sports different from other gambling activities, they are also different from each other.  Because of this, attempts to regulate fantasy sports under existing gambling laws have produced ambiguous guidelines.  For example, in Humphrey v. Viacom, a New Jersey court held that the fantasy sports game at issue was legal because it would be “patently absurd” to conclude that the combination of an entry fee and a prize constituted gambling.[18]  The court reasoned that such a holding would mean that spelling bees, beauty contests, and golf tournaments would also be considered gambling.  Although this holding appears to give fantasy sports a “clean bill of health,” it has been severely limited to its facts.[19]  Therefore, fantasy sports games continue to be arbitrarily analyzed depending on the rules of each particular game.  A better approach is for states to pass specific fantasy sports legislation.

B. Fantasy Sports Specific Law

Montana is currently the only state with specific statutory authorization for fantasy sports.[20]  While the Montana Code is a good starting point, new legislation should expand the law by first defining a fantasy sports game and then requiring the game to meet a two-part test.  First, like in Montana’s Code, a fantasy sports game could be defined as an activity in which “a limited number of persons . . . pay an entry fee for membership in the league” and create “a fictitious team composed of athletes from a given professional sport.”  If the game meets the basic definition, its legal status could be determined based on (1) whether the game involves strategy; and (2) whether strategic decisions lessen the effect of chance on the game.

Part one of the test would require a court to consider whether the game involves strategy.  This inquiry looks only at whether participants’ strategic decisions ultimately affect the outcome of the game.  Part two asks whether a participant can use strategy to effectively “beat chance.”  This requires a court to identify chance elements, such as player injuries or adverse weather conditions, and ask whether a strategic player could reduce the effect of those elements.

When the two-part test is met, the game should be deemed legal.  Alternatively, if chance elements, such as those dependent on random number generators, dice throws, or card shuffles, cannot be controlled, the game should be illegal.  The new law recognizes fantasy sports games as a game of strategy.  By distinguishing them in this way, the law protects the legal status of true fantasy sports games.

VI. Conclusion

Fantasy sports emerged as an American pastime as participation skyrocketed over recent years.  New features, designed to further increase participation, arguably lower the amount of skill involved in the game thereby threatening the legality of fantasy sports. To fix this problem, state legislatures must pass fantasy sports specific laws.  By doing so, states can protect the multi-billion dollar industry.

[1] Darren Rovell, Peyton Manning Injury Could Shift $65 Million in Fantasy Winnings, CNBC (Sept. 6, 2011, 6:57 PM), http://www.cnbc.com/id/44414737/Peyton_Manning_Injury_Could_Shift_65_Million_in_Fantasy_Winnings.

[2] Michael Stein, The Verdict: Yahoo Is Endangering Fantasy Sports, THT Fantasy (Feb. 1, 2011, 5:11 AM), http://www.hardballtimes.com/main/fantasy/article/the-verdict-yahoo-is-endangering-fantasy-sports/.

[3] New York v. World Interactive Gaming Corp., 714 N.Y.S.2d 844, 852 (App. Div. 1999).

[4]Id. at 851 (emphasis added).

[5] Gamble Definition, Merriam-Webster, http://www.merriam-webster.com/dictionary/gamble (last visited Feb. 6, 2013).

[6] E.g., New York v. Hunt, 616 N.Y.S.2d 168, 169 (Crim. Ct. 1994); Valentin v. el Diario la Prensa, 427 N.Y.S.2d 185, 186 (Civ. Ct. 1980); McKee v. Foster, 347 P.2d 585, 590 (Or. 1959); Geis v. Cont’l Oil Co., 511 P.2d 725, 727 (Utah 1973).

[7] Marc Edelman, A Short Treatise on Fantasy Sports and the Law: How America Regulates its New National Pastime, 3 Harv. J. Sports & Ent. L. 1, 27 (2012).

[8] E.g., Affiliated Enter. v. Waller, 5 A.2d 257, 262 (Del. Super. Ct. 1939); State ex rel. Schillberg v. Safeway Stores, Inc., 450 P.2d 949, 955 (Wash. 1969).

[9] Arkansas v. 26 Gaming Machs., 145 S.W.3d 368, 374 (Ark. 2004).

[10] Edelman, supra note 9, at 28

[11] Anthony N. Cabot et al., Alex Rodriguez, a Monkey, and the Game of Scrabble: The Hazard of Using Illogic to Define the Legality of Games of Mixed Skill and Chance, 57 Drake L. Rev. 383, 390 (2009).

[12] Johnson v. Collins Entm’t Co., Inc., 508 S.E.2d 575, 584 (S.C. 1998).

[13] Texas v. Gambling Device, 859 S.W.2d 519, 523 (Tex. App. 1993).

[14] Milwaukee v. Burns, 274 N.W. 273, 276 (Wis. 1937).

[15] See Joker Club L.L.C. v. Hardin, 643 S.E.2d 626, 629 (N.C. Ct. App. 2007); (“[S]kill will prevail over luck over a long period of time”).

[16] Derek Ambrosino, Is Autodraft a Necessary Evil?, THT Fantasy (Jan. 4, 2012, 5:44 AM), http://www.hardballtimes.com/main/fantasy/article/is-autodraft-a-necessary-evil/.

[17] Skill Definition, Merriam-Webster, http://www.merriam-webster.com/dictionary/skill (last visited Feb. 6, 2013).

[18] See generally Humphrey v. Viacom, Inc., No. 06-2768 (DMC), 2007 WL 1797648, at *7 (D.N.J. June 20, 2007)

[19] Eric Sinrod, Fantasy Sports Leagues Participation is not Illegal Gambling, Judge Rules, Find L. (July 3, 2007), http://articles.technology.findlaw.com/2007/Jul/03/10896.html.

[20] Mont. Code Ann. § 23-5-802 (2011).

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The Changing Landscape of Willful Infringement: The Effect of Willfulness as a Question of Law

By Shawna S. Boothe* and John D. Kendzior**

I. Introduction

Under the United States Patent Act, “whoever without authority makes, uses, offers to sell, or sells any patented invention, within the United States or imports into the United States any patented invention during the term of the patent therefor, infringes the patent.”[1]  A finding of willful patent infringement allows the court, at its discretion, to “increase the damages up to three times the amount found or assessed.”[2]  While a finding of willfulness is a sufficient basis for awarding enhanced damages, it does not compel such an award.[3]  Additionally, the court may award reasonable attorney fees to the prevailing party for willful infringement.[4]

Willful infringement significantly affects the technology that patents protect.  In the recent high-profile Apple v. Samsung trial, the patents at issue concerned smartphones and tablets.  The San Jose, California nine-person jury found that Samsung infringed six of seven Apple patents.[4]  The jury awarded Apple $1,049,393,540 in damages—one of the largest awards in an intellectual property case to date.[5]  Moreover, the jury found that Samsung willfully infringed on five of six Apple patents.  Thus, presiding Judge Koh can grant Apple’s request to treble the $1.05 billion jury award and to award attorney fees under 35 U.S.C. §§ 284, 285.

II. Background

The Court of Appeals for the Federal Circuit articulated a standard for evaluating willful infringement in Underwater Devices, Inc. v. Morrison-Knudsen Co.  “Where . . . a potential infringer has actual notice of another’s patent rights, he has an affirmative duty to exercise due care to determine whether or not he is infringing.”[6]  The affirmative duty of a potential infringer included, inter alia, the duty to seek and obtain competent legal advice from counsel before the initiation of any possible infringing activity.  Ensuing case law shaped the willfulness landscape and evaluates willfulness under the totality of the circumstances.

III. Seagate’s Willfulness Standard

Twenty-four years later, the Federal Circuit overruled Underwater Devices and established a two-prong test for proving willful infringement in In re Seagate Technology, LCC.  First, “a patentee must show by clear and convincing evidence that the infringer acted despite an objectively high likelihood that its actions constituted infringement of a valid patent.”[7]  This first prong is a threshold objective standard in which the state of mind of the accused infringer is not relevant.  If the threshold objective prong is satisfied, the patentee must also demonstrate the second prong: “that this objectively-defined risk (determined by the record developed in the infringement proceeding) was either known or so obvious that it should have been known to the accused infringer.”[8] This second prong is a subjective inquiry.  The Court left the development and application of Seagate’s willfulness standard to future cases.  Subsequent case law established that the objective prong tends not to be met where an accused infringer relies on a reasonable defense to a charge of infringement.[9]  Examples of defenses that negate the objective prong of willfulness include invalidity and noninfringement assertions.[10]

Seagate significantly altered two aspects of the willfulness landscape.  First, it elevated the previously lower threshold for establishing willfulness.  Seagate moved away from Underwater Device’s affirmative duty of care—which was akin to negligence—and adopted a more rigorous objective recklessness standard.  The Federal Circuit reasoned that a higher standard of recklessness permitting enhanced damages comports with Supreme Court precedent requiring a showing of recklessness before civil punitive damages are allowed.[11]  Seagate’s heightened standard has made it more difficult for a prevailing party to recover enhanced damages.[12]>  Second, resulting from Seagate’s abandonment of an affirmative duty of care, potential infringers are no longer required to obtain opinion of counsel in order to avoid liability for willful infringement.

IV. Willfulness As a Question of Law

Under Seagate precedent, the willfulness two-pronged inquiry has long been treated as a question of fact.[13]  On June 14, 2012, the Federal Circuit once again transformed the landscape of willfulness by announcing, in Bard Peripheral Vascular, Inc. v. Gore & Associates, Inc., that the threshold prong is henceforth a question of law.  The Bard Court held, “the objective determination of recklessness, even though predicated on underlying mixed questions of law and fact, is best decided by the judge as a question of law subject to de novo review.”[14]  In Bard, the Federal Circuit delineated a rule for two distinct circumstances.  When a defense or noninfringement theory asserted by an accused infringer is purely legal, the objective recklessness of such a theory is a purely legal question to be determined by the judge.  Such purely legal defenses include claim construction and reexamination.  Alternatively, when the objective prong turns on fact questions or on legal questions dependent on the underlying facts, the judge remains the final arbiter of whether the defense was reasonable, even when the underlying fact question is sent to a jury.  Such underlying factual defenses include anticipation or obviousness.  Under the second circumstance, if the defense is a question of fact or a mixed question of law and fact, the court may allow the jury to determine the underlying facts relevant to the defense first, and then it would determine the reasonableness of the defense as a matter of law.

The Bard Court reasoned that the judge is in the best position to determine whether an accused infringer’s defenses are reasonable.[15]  Furthermore, judges have the discretion to award enhanced damages and attorneys fees for willful infringement; therefore, it is logical for judges also to decide the objective prong of willfulness.  To support its holding, the Bard Court also relied upon the Supreme Court’s conclusion that objective baselessness should be a question of law through analogizing objective baselessness for sham litigation to a finding of lack of probable cause to institute an unsuccessful civil law suit—which subjects mixed questions of fact and law to a de novo review.  Bard extended the Supreme Court’s analogy to encompass objective recklessness because Seagate’s objective recklessness and objective baselessness are identical under Federal Circuit precedent.

V. Bard’s Effect on the Willfulness Landscape

This most recent change to willfulness as a question of law substantially affects the overall willfulness landscape in two respects.  First, a question of law is determined by the court, either on a pretrial motion for partial summary judgment or on a motion for judgment as a matter of law at the close of the evidence.[16]  Prior to Bard, few of these motions were granted because willfulness was ultimately a question of fact to be decided by the jury after trial.  Now that willfulness is a question of law, an avenue is created for disposing of willfulness allegations by judicial decision prior to trial.   Therefore, courts will likely experience increased filings of such motions due to this new avenue, and movants likely will experience greater success—not necessarily on the merits of the motion but on the sheer ability of courts to grant the motions without needing to submit the issue to the jury.

Secondly, the decision in Bard creates a disjointed pairing of a question of law with a standard for proving facts.  Seagate requires that the threshold prong of objective recklessness be proven by clear and convincing evidence.  Typically, clear and convincing evidence is the standard for proving questions of fact, which was consistent when willfulness was a question of fact.  In holding that the threshold prong of objective recklessness is a question of law, the Bard court failed to address or change the standard of proof required for this prong.  Thus, Seagate and Bard, understood together, create an issue of law that still must be proven by the standard for an issue of fact.

In an earlier concurring opinion, Justice Breyer addressed the exact problem we now face with Seagate and Bard.[17] Justice Breyer, in his concurring opinion in Microsoft Corp. v. i4i Limited Partnership, firmly stated that the clear and convincing evidentiary standard should only apply to questions of fact and not to questions of law.  Additionally, Justice Breyer instructed courts to prevent “the ‘clear and convincing’ standard from roaming outside its fact-related reservations . . . .”[18]  One does not have to make a significant inferential leap to conclude that Justice Breyer would admonish the Federal Circuit for establishing willfulness as a question of law that applies the clear and convincing evidence standard of proof.  Although both remain “good” law, there is undeniable tension between Seagate and Bard that will likely be addressed in subsequent case law.

VI.       Conclusion

The willfulness landscape has undergone two significant changes within the last five years.  First, the willfulness standard in Underwater Devices was replaced by the standard set forth in Seagate, which heightens the burden of proving willfulness by requiring objective recklessness as opposed to negligence.  Additionally, Seagate abandoned Underwater Devices’ duty of care and duty to seek opinion of counsel.  However, no change could be more significant than the change that occurred in Bard, which held that willfulness is as a question of law rather than a question of fact.  As a question of law, judges may determine the threshold prong of willfulness without submitting the issue to the jury.  The judge could dispose of a willfulness allegation by granting a motion for summary judgment or judgment as a matter of law.  Thus, the authors posit that the courts will see an increase in such motions, and movants will experience greater success solely because of the new avenue to dispose of willfulness allegations.  Another effect of the change in Bard is the tension created by joining a question of law with the burden of proving a question of fact—clear and convincing evidence.  The authors posit that Justice Breyer would strongly disapprove of such joining based on his special concurrence in i4i, and the tension will be resolved in subsequent case law.

* J.D. Candidate, University of Illinois College of Law, expected 2013. B.A., Mathematics and Philosophy, University of Saint Thomas, 2010.  Firstly, I would like to thank James Hanft at Schiff Hardin LLP for his insights and guidance during the 2012 summer associate program, which sparked my interest in this topic.  Secondly, I am grateful to the editors of the Journal of Law, Technology, and Policy for their support while writing this piece.  Lastly and most importantly, I would like to thank my family for their continued support throughout the years.

** J.D. Candidate, University of Illinois College of Law, expected 2013. B.S., Finance and Information Technology, Marquette University, 2010.  Firstly, I would like to thank my co-author for introducing me to this topic and being a pleasure to work with.  I would also like to thank my fellow Journal of Law, Technology, and Policy editors and members for their insights and advice throughout the writing and publication process.  Lastly, I would like to thank my family for their encouragement of my legal education.

[1] 35 U.S.C. § 271 (2010).

[2] 35 U.S.C. § 284 (2011); e.g., In re Seagate Tech., LLC, 497 F.3d 1360, 1368 (Fed. Cir. 2007) (“Absent a statutory guide, we have held that an award of enhanced damages requires a showing of willful infringement.”).

[3] State Indus., Inc. v. Mor-Flo Indus., Inc., 948 F.2d 1573, 1576 (1991) (citing Modine Mfg. Co. v. Allen Grp., Inc., 917 F.2d 538, 542–43 (Fed. Cir. 1990)).

[4] 35 U.S.C. § 285 (1952).

[5] Apple, Inc. v. Samsung Elecs. Co., No. 11-cv-01846-LHK at 2–7 (N.D. Cal. Aug. 24, 2012) (amended verdict form), available at http://cdn.slashgear.com/wp-content/uploads/2012/08/ApplevSamsung-1931.pdf; Jessica E. Vascellaro, Apple Wins Big in Patent Case, Wall St. J. (Aug. 25, 2012, 1:41 PM), http://online.wsj.com/article/SB10000872396390444358404577609810658082898.html.

 [6] Apple, No. 11-cv-01846-LHK at 15.

[7] Underwater Devices, Inc. v. Morrison-Knudsen Co., 717 F.2d 1380, 1389–90 (Fed. Cir. 1983).

[8] > In re Seagate Tech., LLC, 497 F.3d 1360, 1368 (Fed. Cir. 2007).

[9] Id.

[10] Spine Solutions, Inc. v. Medtronic Sofamor Danek USA, Inc., 620 F.3d 1305, 1319 (Fed. Cir. 2010).

[11] Advanced Fiber Techs. (AFT) Trust v. J & L Fiber Servs., Inc., 674 F.3d 1365, 1377 (Fed. Cir. 2012).

[12]See Safeco Ins. Co. of Am. v. Burr, 551 U.S. 47, 71 (2007) (noting that a reckless disregard of a requirement of the Fair Credit Reporting Act would qualify as a willful violation that makes a person civilly liable to the consumer).

[13] Siraj Husain, Note, The Willfulness Pendulum Swings Back: How Seagate Helps Level the Playing Field, 28 Loy. L.A. Ent. L. Rev. 239, 239–240 (2008).

[14] Cohesive Techs., Inc. v. Waters Corp., 543 F.3d 1351, 1374 (Fed. Cir. 2008); Stryker Corp. v. Intermedics Orthopedics, Inc., 96 F.3d 1409, 1413 (Fed. Cir. 1996).

[15] Bard Peripheral Vascular, Inc. v. Gore & Assocs., Inc., 682 F.3d 1003, 1007 (Fed. Cir. 2012).

[16] > Id. at 1006.

[17] DePuy Spine, Inc. v. Medtronic Sofamor Danek, Inc., 567 F.3d 1314, 1324 (Fed. Cir. 2009) (quoting Warner Jenkinson Co., Inc. v. Hilton Davis Chem. Co., 520 U.S. 17, 39 n.8 (1997)).

[18] Microsoft Corp. v. i4i Ltd. P’ship, 131 S.Ct. 2238, 2253 (2011) (Breyer, J., concurring).

[19] Id.

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Piercing the SHIELD Act

By Jessica Lanfordϯ

On August 1, 2012, Rep. Peter DeFazio (D-Or.) introduced a bipartisan bill that seeks to protect American start-ups from the destructive costs of frivolous lawsuits brought by patent trolls.[1]  Backed by the software and computer hardware companies that it seeks to protect, the Saving High-Tech Innovators from Egregious Legal Disputes Act (SHIELD) effectively forces Non-Practicing Entities (NPEs) to pay defendants’ legal costs.

This Article provides an overview of the bill, then analyzes its effectiveness by asking three questions: 1) What is the NPE problem? 2) Is fee-shifting a sensible policy instrument? and 3) Do we need to go beyond existing law to prevent frivolous lawsuits?  Ultimately, a closer look shows that the system proposed by the SHIELD Act is premature, ineffective, and unnecessary.

Overview of the SHIELD Act:

The SHIELD Act proposes a “loser-pays” system[2] for cases involving computer hardware or software patents, with the following language:

(a) In General—Notwithstanding section 285, in an action disputing the validity or alleging the infringement of a computer hardware or software patent, upon making a determination that the party alleging the infringement of the patent did not have a reasonable likelihood of succeeding, the court may award the recovery of full costs to the prevailing party, including reasonable attorney’s fees, other than the United States.[3]

The preamble suggests that the statute applies to both validity and infringement actions.  But the bill then limits the system to apply only against the party “alleging the infringement.”  Thus, the SHIELD Act is a one-way system: alleged infringers can recover their costs if they prevail in court—but patentees may not seek recovery against accused infringers who assert frivolous defenses.[4]

The bill also provides definitions for “Computer,” “Computer Hardware Patent,” and “Software Patent.”  If passed, the bill will define “software patent,” for the first time, to mean: a) “any process that could be implemented in a computer regardless of whether a computer is specifically mentioned in the patent,” or b) a “computer system that is programmed to perform [such] a process.”[5]  But the bill stops short of endorsing the controversial software patent with a disclaimer: the SHIELD Act should not be “construed as amending or interpreting categories of patent-eligible subject matter . . . .”[6]

1. NPE Problems: Where’s the Beef?

An NPE is defined as an entity that does not manufacture products itself—also known as a “patent troll.”[7]  Universities, independent inventors, and failed businesses are all examples of NPEs.  But the term “patent troll” can also mean a specific type of NPE that buys patents from others merely to assert them.  Critics liken these businesses to the fabled greedy troll who hijacks bridges, then threatens to gobble-up anyone who passes his way.[8]

Is the SHIELD Act really anti-troll legislation?  Supporters claim that the fee-shifting provision could help “the good guys” beat patent trolls.[9]  But the bill’s effects are far broader than its proponents suggest: any plaintiff that alleges infringement without a “reasonable likelihood of succeeding,” could be forced to foot its opponent’s legal bills.[10]  And by leaving the construction of “a reasonable likelihood of succeeding” up to the court, the SHIELD Act could end up creating more litigation than it seeks to prevent.[11]

In a news release, Rep. DeFazio claimed that patent trolls “pad their pockets by buying patents on products they didn’t create and then suing the innovators who did the hard work and created the product.”[12]  But current evidence of NPE activity seems to show otherwise.   For example, last year, one of the largest publicly traded NPEs reported that it paid more in royalties to inventors than it did to the patent attorneys who enforce their patents.[13]

Rep. DeFazio also claims that patent trolls’ lawsuits hurt American innovation and tech startups.[14]  His belief is widely shared, but it lacks credible support. [15]  In reality, NPE activity has the potential to spur innovation, and stimulate investment in start-ups.[16]   And the NPEs that Rep. DeFazio targets could actually help the little guy.  By buying patents from inventors and owners who can’t afford to market their own technologies, NPEs give non-manufacturing inventors the opportunity to monetize their patents—one that they may otherwise not have.

The bill is also intended to neutralize NPEs’ controversial business practices.  Specifically, Rep. DeFazio points to patent trolls’ habit of buying broad patents for the purpose of filing “flimsy lawsuits” for infringement.[17]  Perhaps he is unaware of recent evidence that the patents enforced by “trolls” are substantially similar to patents litigated by practicing entities.[18]  For example, patents litigated by NPEs have the same range of claims and references cited as other litigated patents.[19]  And contrary to popular belief, a recent study shows that the patents NPEs typically litigate are more important and influential than those litigated by non-NPE plaintiffs.[20]

Yet, no studies show that NPEs actually file frivolous lawsuits, or that they are routinely accused of Rule 11 violations.  So, where’s the beef?  Until we have a realistic understanding of so-called “patent troll” litigation and NPE behavior, we should refrain from passing laws aimed at limiting their activity.

2. Is Fee-Shifting a Sensible Policy Instrument?

For more than 200 years, litigants in the United States have operated under the “American Rule”: each party pays its own litigation costs, whether it wins or loses.  In contrast, under both the “English Rule” and the SHIELD Act, the loser pays.

Despite its effectiveness in discouraging frivolous lawsuits, the English Rule produces unwanted results.  First, in a “Loser Pays” world, a potential plaintiff decides whether to litigate by considering its financial risks, rather than the merits of its case.  As a result, plaintiffs with meritorious claims that are not sure-fire winners will give up on litigation for fear of paying the defendant’s costs.

Second, the English Rule encourages more litigation than its American counterpart by reducing settlements, particularly in cases involving higher stakes and confident parties.  Naturally, in a “Loser Pays” system, a confident high-stakes litigant will pursue trial for full recovery.  But the American Rule reduces litigation: a confident party will prefer to settle when the cost of doing so is less than the cost of victory at trial.

Finally, if the British experience is any indication, patent enforcement costs arising from the SHIELD Act could drown small businesses and startup patentees[21]—the same entities that the bill claims to protect.  Therefore, unless we want to limit small businesses’ access to courts, the SHIELD Act and its “Loser Pays” system is ineffective.

3. Do We Need to Go Beyond Existing Law to Prevent Frivolous Lawsuits?

If supporters of the SHIELD Act simply want protection from frivolous lawsuits, then why do they need this bill?  Existing patent law allows the court to award reasonable attorney’s fees to the prevailing party in “exceptional” cases, under Section 285.[22]  Courts typically award attorney’s fees under Section 285 when evidence shows that the plaintiff brought litigation in bad faith.[23]   But without a showing of bad faith, attorney’s fees under Section 285 are unavailable.[24]

A plaintiff of a frivolous lawsuit is also subject to sanctions under Rule 11 of the Federal Rules of Civil Procedure.  Under Rule 11, attorneys are required to certify that the papers they file are legally sound, rooted in fact, and “not interposed for any improper purpose.”[25]

Yet the SHIELD Act seeks to shift the standard’s focus from a plaintiff’s conduct to his or her perceived probability of success.  The bill proposes that even in the absence of bad faith, a patentee should be liable for attorney’s fees based on the court’s opinion of his or her “reasonable likelihood of success.”

The SHIELD Act is a hollow sword.

If passed, the SHIELD Act has the potential to hurt those that it claims to protect.  The threat of overwhelming legal costs will keep small innovators from litigating worthy claims, giving alleged infringers a free pass.  At the same time, the bill’s supporters seek to expand existing protections against frivolous lawsuits without any meaningful understanding of NPE activity.  Before we even consider passing legislation aimed at limiting the behavior of patent trolls, we need to take a close look at what they actually do.

ϯ J.D. Candidate, University of Illinois College of Law, expected 2013.

[1] Press Release, Congressman Peter DeFazio, DeFazio Introduces SHIELD Act to Protect American Innovation, Jobs (Aug. 1, 2012), available at http://defazio.house.gov/index.php?option=com_content&view=article&id=792:defazio-introduces-shield-act-to-protect-american-innovation-jobs&catid=69:2012-press-releases; Cong. Research Serv., H.R. 6245: Saving High-Tech Innovators from Egregious Legal Disputes Act of 2012, govtrack.us,  http://www.govtrack.us/congress/bills/112/hr6245 (last visited Oct. 15, 2012).

[2] Loser Pays System Introduced in Congress, PatentlyO (Aug. 9, 2012, 10:21 AM), http://www.patentlyo.com/patent/2012/08/loser-pays-system-introduced-in-congress.html.

[3] SHIELD Act of 2012, H.R. 6245, 112th Cong. (2012).

[4] Ron Katznelson, Here They Go Again – This Time with the Patent SHIELD Act, IPWatchdog (Aug. 26, 2012, 7:25 AM), http://www.ipwatchdog.com/2012/08/26/here-they-go-again-this-time-with-the-patent-shield-act/id=27476/.

[5] H.R. 6245.

[6] Id.

[7] Michael Risch, Patent Troll Myths, 42 Seton Hall L. Rev. 457, 459 (2008); David L. Schwartz & Jay P. Kesan, Analyzing the Role of Non-Practicing Entities in the Patent System 2 (July 25, 2012) (Ill. Program in Law, Behavior and Soc. Sci. Paper No. LBSS13-03; Ill. Pub. Law Research Paper No. 13-01; Chi.-Kent Coll. of Law Research Paper No. 2012-03), available at http://ssrn.com/abstract=2117421.

[8] Peter Christen Asbjørnsen & Jørgen Moe, Three Billy Goats Gruff, in 37 Popular Tales from the Norse 275–76 (George Webbe Dasent trans., London, George Routledge and Sons 2d ed.); Schwartz & Kesan, supra note 7, at 2.

[9] Julie Samuels, Can You Believe It? Legislation that Would Actually Help Fix the Patent System, Electronic Frontier Found. (Aug. 1, 2012), https://www.eff.org/deeplinks/2012/07/can-you-believe-legislation-would-actually-help-fix-patent-system.

[10] H.R. 6245.

[11] Timothy J. Maier, The Proposed Saving High-Tech Innovators from Egregious Legal Disputes (SHIELD) Act, Maier & Maier, PLLC (Aug. 10, 2012, 2:47 PM), http://www.postgrant.com/2012/08/the-proposed-saving-high-tech-innovators-from-egregious-legal-disputes-shield-act.html.

[12] Press Release, Congressman Peter DeFazio, supra note 1.

[13] ACACIA Research Grp., Annual Report (Form 10-K), (Feb. 29, 2012), available at http://biz.yahoo.com/e/120229/actg10-k.html; Schwartz & Kesan, Analyzing the Role of NPEs in the Patent System, Patentlyo (Aug. 21, 2012, 4:04 AM), http://www.patentlyo.com/patent/2012/08/analyzing-the-role-of-npes-in-the-patent-system.html.

[14] Press Release, Congressman Peter DeFazio, supra note 1.

[15] Risch, supra note 7, at 492–93.

[16] From Exposing NPE Myths to Explaining NPE Math, RPX, http://www.rpxcorp.com/index.cfm?pageid=14&itemid=25.

[17] Press Release, Congressman Peter DeFazio, supra note 1.

[18] Risch, supra note 7, at 480; Schwartz & Kesan, supra note 13.

[19] Risch, supra note 7, at 480.

[20] Id. at 481.

[21] Katznelson, supra note 4; Richard Tyler, Inventor Fury as Patents Prove Too Costly to Defend, Telegraph (Mar. 8, 2012, 11:11 AM), http://www.telegraph.co.uk/finance/yourbusiness/9130815/Inventor-fury-as-patents-prove-too-costly-to-defend.html.

[22] 35 U.S.C. § 285 (2006); Alexander Poltorak, Proposed SHIELD Law Is Nothing but a Gift to Infringers, Hill (Aug. 10, 2012, 3:15 PM), http://thehill.com/blogs/congress-blog/technology/243135-proposed-shield-law-is-nothing-but-a-gift-to-infringers.

[23] ICU Med., Inc. v. Alaris Med. Sys., Inc., 558 F.3d 1368, 1379–80 (Fed. Cir. 2009).

[24] Brooks Furniture Mfg. ., Inc. v. Dutailier Int’l, Inc., 393 F.3d 1378, 1381 (Fed. Cir. 2005).

[25] Cooter & Gell v. Hartmarx Corp., 496 U.S. 384, 393 (1990).