Non-practicing entities, also known as patent trolls, find midsize companies make ideal targets for infringement claims. Online retailer is fighting back.

Kevin Casey, Contributor

February 4, 2013

12 Min Read

Online retailer does well by the business metric that matters most: Money. In 2012, the 50-person company sold $35 million worth of watches. The company expects to beat that figure by a considerable margin this year, according to CFO Simon Zelman. But the website's growth has attracted some unwelcome attention.

"My introduction to patent trolls probably started about two years ago," Zelman said in a phone interview. "The success of Ashford, and appearing in a trade magazine such as Internet Retailer, basically gives [them] a list -- it's almost like a roadmap for these guys -- where they peruse through this information and say: 'Aha! This is a good target.'"

The term patent troll -- or its counterpart, non-practicing entity (NPE) -- refers to corporations whose sole business is the ownership and enforcement of United States patents. By definition, NPEs have no other product or service. They acquire patents, often technology-related in nature, and attempt to generate revenue from them by pursuing licensing deals, sales or patent-infringement litigation. Unlike operating companies that pursue patent enforcement for competitive reasons, NPEs in this context exist solely to own patents and make money from them.

[ Defending patents against NPEs costs American businesses big time. Learn more about why Patent Trolls Decimate Innovation. ]

"A troll has no legitimate business interest to protect, and the patent laws were not intended to protect trolls. A troll merely seeks to make a return on its investment in having purchased the patent," Kurt Olender, a partner with the law firm OlenderFeldman, said in an email interview. "To be blunt, patent trolls are regarded as extortionists and opportunistic."

Critics of the practice point to the broad, commonplace or outdated nature of many of the patented technologies or processes that NPEs attempt to enforce, such as distributing a news release via email or, in Ashford's case, buying and selling goods on the Internet. Zelman said that while patent documents and the legal language of patent-infringement claims tend to be heavy on complex technical jargon, the process or technology in question is often very simple. "At the service level, they can be telling you: You looked at a screen [and] by looking at that screen you infringed on a patent," Zelman said. "Everybody in the world is looking at a screen every day. It's that ridiculous."

Ashford has been approached "more than three times" by NPEs claiming patent infringement, according to Zelman. He could not publicly disclose names or the specific outcomes of those disputes for legal reasons, but he offered a clear picture of what it's like to be on the receiving end of patent-infringement claims -- and of why NPEs are sometimes successful in their pursuit of financial settlements. The practice is widespread, according to Zelman.

"It is prevalent," Zelman said. "Most executives that I'm in touch with have had at some point in time an occurrence where they've had to deal with a patent troll."

Ashford's former president Eli Katz now runs an e-commerce trade group, theEmob, whose 40 or so members collectively do more than $1 billion in annual sales. (Ashford is a member of the group.) According to Katz, roughly half of the trade association's member companies have been the target of patent-infringement actions. All but one of those claims were made by NPEs, Katz said.

"There are a handful of trolls that have targeted midsize companies in what can best be interpreted as a shakedown," Katz said in an email.

There's a reason some NPEs favor midsize companies for patent-related licensing deals and lawsuits, according to Olender. "Small businesses generally do not make good targets because they cannot afford a large enough fee for it to be worthwhile as a business model for the troll. The most efficient targets are middle market companies [with sales of] $50 million to $250 million," Olender said. "They can afford fees of $50,000 [to] $200,000 and the cost of defense will typically exceed these levels of license fees."

NPEs target large companies like an or a Walmart, too, but Olender said those firms are "riskier pursuits for the trolls" because of their corporate muscle and high profile. "Larger companies typically also have a vested business [or] industry interest in ensuring that trolls are defeated," he said. Olender described the "business model of a troll" as such: Price the patent license or sale high enough so that it's profitable, but low enough so that it's less expensive than defending against a lawsuit.

Ashford is essentially a case study in this model. While Zelman's first instinct is to challenge the validity of the infringement claims, his job as CFO requires him to weigh costs against potential benefits. The cost of mounting a legal defense can quickly surpass the cost of a settlement fee.

"I don't believe in paying these guys. I believe in trying to fight them, but that's up to a point," Zelman said. "More than likely, you're going to win. But at what cost? The instinct initially is to fight them, see what we can do to get them off our back. We'll respond at the point that we feel we need to respond and, in certain cases, put the pressure where we can. But at some point there is a decision that is made." Katz of theEmob provided InformationWeek with copies of a letter and corresponding term sheet that the law firm Capital Legal Group sent on behalf of Cronos Technologies. In court documents, Cronos Technologies lists a mailbox at a shipping store in Wilmington, Del., as its address. The letter recipient's name was redacted. (Zelman said that Cronos is not one of the NPEs that has pursued Ashford for patent infringement.) The letter, regarding U.S. patent 5,664,110, states: "CLG has determined that your company should be interested in discussing licensing opportunities related to the '110 patent based upon the features and services provided by your company via its online retail portal. Accordingly, CLG would like the opportunity to discuss the licensing opportunities that are presently available."

That opportunity: Pay a one-time, non-refundable licensing fee of $185,000.

In a TED talk about his fight against a patent-infringement claim, founder Drew Curtis said: "You need to know that the average patent troll defense costs $2 million and takes 18 months when you win. That is your best case outcome when you get sued by a patent troll."

The '110 patent covers a "remote ordering system." The beginning of the patent's abstract reads: "A remote ordering system provides a user the ability to build and edit one or more order lists, resident in memory within a user device, and the further ability to review and manipulate a user interpretable display of the contents of such lists. A system comprising merchant stock databases, a data format/transfer computer (DFTC) and display/processor units (DPUs) (the user devices) enable creation and transmission of the order lists."

The rest of the abstract and patent documentation is full of similar language and related diagrams. Yet it appears much of it describes what would today be more commonly called e-commerce. The "Background of the Invention" section, for instance, begins: "Remote ordering systems have been proposed for providing homeowners and business-persons the ability to order staple items from one or more merchants without the need to travel to a merchant location. However, such prior art systems have failed to provide the user with adequate information necessary for tracking or editing orders made or lists compiled."

The '110 patent was assigned in 1994 to a company called Highpoint Systems. According to Olender, "most trolls acquire old patents that were never intended to apply to current technology." Among the other patents cited in the '110 documentation is patent 5,319,542, originally filed in 1990 for a "system for ordering items using an electronic catalogue" and assigned to IBM. That patent's background information describes the challenges mail-order retailers faced pre-Internet: "The entire process, from preparing the catalog to receipt of orders, often took several weeks, and possibly months." It also notes the limitations of commerce on early online services such as Prodigy.

The Cronos letter and term sheet were signed by Capital Legal Group's managing partner, Mel Barnes. In a phone interview, Barnes declined to comment on specific clients or cases, but he confirmed that Cronos Technologies is a non-practicing entity. Barnes said that all of Capital Legal Group's clients except for Cronos Technologies are operating companies that generate revenue from businesses other than owning and enforcing patents.

"We're a law firm that helps companies monetize patents through licensing or sales," Barnes said. Businesses pay fees not just to file patents but also to maintain their ownership over time. "Some companies get five -- some companies get 500 -- patents a year, and seven [to] 10 years later they don't know if those patents are valuable or not valuable. They tend to maintain them, and every three-and-a-half years there are maintenance fees. For some companies, that's millions of dollars a year in patent maintenance fees. Sometimes they let them go abandoned and lapse for a failure to pay the maintenance fees, and we try to help them figure out which of their patents are valuable and being perpetually infringed by the marketplace and which aren't. Sometimes clients like to sell those patents, sometimes they like to license them, and sometimes they like to enforce them on their own. We help companies generate revenues from patents they've developed or acquired that would basically be otherwise useless to them."

Barnes is also listed as the president of Cronos IP Solutions, "a global patent monetization firm specializing in contingency-based enforcement of patents," on that firm's website. The "Executives" link and corresponding Web page do not appear in the site's navigation, but the page is accessible via search or direct URL. The site's content regularly refers to the firm simply as "Cronos." Barnes said that Cronos Technologies and Cronos IP Solutions are separate, unrelated entities.

Asked about the term "patent troll," Barnes noted that it has been around for a while. "It's a little bit of eighth-grade name-calling from our perspective. Lots of billion-dollar companies that are operating companies, they develop patents and often don't have products covered by these patents. When they go to enforce these patents, they're generally not considered a troll simply because they sell other products," Barnes said. "But when you have a sole inventor who develops a patent but doesn't have the financial resources to commercialize it, companies revert to name-calling them. It doesn't really affect us one way or another. There doesn't seem to be a lot of logic or merit behind the term." Barnes said that some patents are too broad or otherwise lack merit. "The courts hold patents invalid regularly," he said. "I definitely agree that some patents [are] issued that shouldn't [be]."

While the threat of litigation is an ordinary NPE strategy, the conventional wisdom says that NPEs want to avoid the courtroom. "The troll is usually seeking to avoid litigation costs as that reduces its return on investment," attorney Olender said. "Thus, they seek a quick resolution and payment." That has been Zelman's experience at Ashford, too: "Their game is to get in and get out," he said.

In 2012, though, Cronos Technologies sued the likes of J. Crew, Abercrombie & Fitch, Nutrisystem and GNC -- in all four cases claiming infringement of the '110 patent. Barnes said lawsuits are often the only effective method of patent enforcement. Polite letters, like the aforementioned one Barnes sent on behalf of Cronos Technologies, usually go unanswered. "They'll just ignore you," he said, adding that some businesses receive dozens of such letters every month. "The only way you can get their attention is to sue them." One Capital Legal Group client, for example, has around eight different patent-related lawsuits pending, according to Barnes. (Capital Legal Group is not a litigation firm. It hires other law firms to handle litigation work on behalf of its clients.) While Barnes said more patent holders are now securing licensing deals without litigation, that usually doesn't occur until they've shown a willingness to go to court. "Until you have a credible threat of litigation -- such as a having a big name like an IBM or a Microsoft, or until you have already sued somebody -- people won't take you seriously," Barnes said.

Barnes also pointed out that some large companies use NPEs, also called non-operating companies or non-operating units, to manage patents as well. "Some of the big companies will decide that they don't want to be party to a suit, so they'll assign their patents to a newly formed LLC and use that LLC to monetize those patents," he said.

Finding potential patent infringers is a matter of putting in the hours, according to Barnes.

"It's just brute force. We look at companies that have similar patents to the one that we're looking at for infringement or have products in that industry, and we just have to hardcore do the analysis to see whether they infringe or not," Barnes said. "There's no shortcut. It's just tedious, time-consuming effort to look at products that might infringe and conclude one way or the other."

Zelman, Ashford's CFO, declined to state how much patent-infringement claims have cost his bottom line. Ultimately, he thinks of them as "a nuisance." Zelman doesn't expect NPEs to stop pursuing claims against businesses like Ashford any time soon, though he's reasonably optimistic about his and his peers' chances for better defending against them. Among other reasons why, Zelman thinks companies will begin to put more pressure on their software vendors and other technology suppliers for legal support in the event of patent-infringement claims, something he said has been assumed in the past but rarely actually exists.

"Executives -- people who are responsible for making decisions of acquiring, purchasing, licensing -- I think as we become more sophisticated in documenting what it is that we're agreeing to license and the fees in these documents, we're getting smarter," Zelman said. "People are starting to realize that there's a requirement that we need to build in some kind of defense mechanism."

In the bigger picture, Zelman also expects more companies like Ashford -- successful, but far from household names -- will simply decide to no longer support the NPE business model.

"There are more and more folks that are taking a stand," Zelman said. "It's going to be a little more painful, but we're going to take the stand and we're going to fight. We're going to push and continue to push and potentially expose fraudulent litigation, because most of the time this is what it is."

About the Author(s)

Kevin Casey


Kevin Casey is a writer based in North Carolina who writes about technology for small and mid-size businesses.

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