I recently had the opportunity to chat on the record with Ashley Keller, a co-founder of Gerchen Keller Capital. Ashley will be speaking at the upcoming 2015 IP Dealmakers Forum in New York City on December 7, 2015, on a panel entitled titled All About Patent Quality — How to Invest in Powerful Patents.
In part one of our interview we focused on what caused the patent market to deteriorate in the first place. Not surprisingly, Keller pointed to the Supreme Court’s decision in eBay as the first step down what has become an unfortunately long path that has chiseled value away from individual patents and patent portfolios alike.
In the final segment of our conversation we pick up our discussion with me asking Ashely where he sees that patent market heading, and whether he predicts a rebound for the market anytime soon.
Without further ado, here is the final segment of my two-part interview with Ashley Keller.
QUINN: So where do we go from here in the patent market? As far as you can tell is the market for software related inventions completely soft? Is it showing some signs of rebound? What do you see?
KELLER: I can tell you from my experience that at Gerchen Keller Capital we are in the business of embracing legal and regulatory risk, and in the patent world, we’re comfortable warehousing risk. But we’re not comfortable with risk we can’t handicap, right? And to stick on this point for a while, the problem with Alice in software-related claims is that I don’t know how to apply the test that’s been announced. ‘I know it when I see it’ is not a sufficiently robust test for us to put our investors’ capital on the line. So until there’s more clarity around who’s going to win and who’s going to lose these cases, we have shied away from software and software-like claims because we don’t even know how to price for this risk because the law is so uncertain. To put a little bit of a cynical gloss on it, we feel like who your judge is and what he had for breakfast this morning is what’s going to determine whether your claims survive. And that’s not risk we are prepared to underwrite.
For us, there are plenty of software claims that five years ago would have been fantastic claims that we’re passing on because we’re just not comfortable shouldering an unknowable risk. The test is too loosey-goosey. I’d far rather the Federal Circuit just say software claims are not eligible for patent protection. I think that would be manifestly incorrect as a matter of law, but at least it would provide clarity so business, industry and investors could work around that or decide to go to Europe, where 101 is not an issue. But the status quo is really painful with respect to those sorts of claims, because I’ve never heard anybody—and we’ve spoken to lots of great patent litigators on this—I’ve never heard anybody explain to me what the Alice test in practical application means or how it applies to particular claims.
QUINN: Yeah, it’s hard. I agree to a large extent that it depends upon the judge that you have and whether they are philosophically in favor of patents or whether they are philosophically opposed to patents. And I don’t know. Do you remember back in – it was probably the 80s and early 90s – when the Federal Circuit was going through this and they had the Freeman-Walter-Abele test that they used for a while. Ultimately they abandoned that test because it came to the point where you could articulate the test and then the judge who was deciding could really do whatever they wanted because there was just no tethering of the test to any kind of objective reality. And I just see that is exactly what is happening now. I don’t know how we get out of this place but I do think it’s doing real damage to innovation in the U.S.
KELLER: I think that’s right. Uncertainty is a real killer when it comes to this. It’s worth taking a step back and remembering that the reason we have a patent system in the first place is to encourage research and development, which are fixed-cost-intensive propositions. If you don’t have a patent system in place, no one’s going to publish their research, and no one’s going to invest those R&D dollars, because they can’t get a reasonable return and everybody could free-ride off of their efforts by reverse engineering their product and figuring out what path they chose to get to the most efficient solution. Patents exist to serve a very important economic function. If you reduce the certainty of the returns from those R&D investments, standard economic lessons will teach that you’re going to get fewer R&D investments because either you’re going to need to reap a much higher rate of return on invested capital that’s just not possible for that opportunity, or you’re going to move elsewhere where you can get those returns because capital is mobile.
QUINN: I know that your investing decisions are changing because of the difficulty in assigning risk and understanding any kind of outcomes, but do you have a sense of what that is doing to the broader market, for the people who would otherwise normally be coming to you for money or the people that you’re turning away? Where do they go or do they go anywhere now?
KELLER: From our vantage point, our quality threshold (which was always very high) has risen even higher. Cases need to be very strong for us to make an investment. And the things we’re turning away probably would have been funded in a New York minute a couple years ago, but now they are finding it more difficult to attract funding and they might not find funding at all.
I think the biggest hit is on the vast majority of inventions, and I say this not as an insult to them, but I’ll call them incremental inventions. They’re not path-marking, they’re not foundational, they’re not standard essential, they’re not transforming the way the world works; they’re just minor but still important improvements on the preexisting paradigm for how technology works. Those inventions are still valuable. They still deserve something. But it’s become very difficult for those inventors and patent holders to get compensated. A marginal invention is only worth a marginal amount of money, and that’s fair; a defendant shouldn’t have to pay an arm and a leg for something that just made a minor improvement over the prior art. But they should have to pay something. The problem is that litigation is now the path to monetization, and the cost of litigation is so substantial because people are really digging in. So now the only cases worth funding are often the ones where there’s high eight, low nine figures worth of damages and you can fight for three or four years and take the risk of IPR and a Federal Circuit decision and potentially a remand and a long path to money because there’s a big enough pot at the end for everybody to get paid. But a case that might be worth a couple hundred thousand dollars, that case is very hard to monetize. And the licensing model where people are resolving things outside of the court system has really dried up in this new environment. So those patent holders, which are again in my view at least the vast majority of patent holders, they’re really suffering.
QUINN: I guess the one question I’d really like to ask you is what are you doing in this market? What has your business become? I suppose it has changed quite a bit over the last particularly few years, but even before that it was probably morphing little by little, right? So my question is – where do you guys find yourself putting your money and your energies?
KELLER: It’s better to be lucky than good, and that definitely applies to us. In a perverse way, I think we were fortunate to have started investing in the space after the pendulum was already swinging pretty hard and you could see that it had a ways to go. We entered the market when we knew we had to be cautious. We’re investing in high-value cases where path-marking technology is on the line. We’re often doing portfolio deals where we’re not resting on one or two patents with only a handful of relevant claims, but we can go in with a substantial book of patents to show the defendants that they’re not going to be able to knock them all out or make non-infringement arguments for all of them. And we’re tending toward higher dollar value deals, which are much more diligence-intensive, because when you’re going to put that kind of capital on the line, you really need to kick the tires thoroughly. We do a lot of heavy lifting on a smaller number of deals, as opposed to doing a lot of small deals and hoping that a couple of them come out good. We’re just focused like a laser on quality.
QUINN: You’ve said a couple things there that interest me. You want to see enough patents because there is just the reality that if they get challenged at least some are going to fall by the wayside. But then again you’re talking about quality. So it’s not quite the quantity game that it used to be, is it?
KELLER: I think that’s accurate, and to be clear, we will invest in cases where it’s just one or two patents if we like them enough. But as between one or two patents and an inventor with lots of continuations pending and a thousand issued claims, the latter is going to be lower risk and thus get a lower cost of capital.
Overall, on an average deal size basis, the average deal is larger than when we started. We’re taking concentrated bets on things we’ve diligenced up and down where the stakes are really high, as opposed to smaller bets where maybe we’re trying to take a broad-based approach to monetization and knowing we’re going to lose a few. We’re still going to lose a few of the big ones, too, I might add. But in this environment, we’re presuming that everybody is going to fight, so we’d better have thought through the next five moves and know that we’re right on infringement, validity and damages. The days when you could say, ‘Yeah, the infringement read is good, and who knows on validity, but the defendant will pay’—those days I think are largely over.
QUINN: I have my opinions and maybe you’ve read my opinions, but let me ask you the question. Do you really believe that if the Supreme Court were to come out and say that enhanced images are discretionary, that they can be awarded by the district court in the same way that they talked about with attorneys’ fees, that there would be a significant move in the market? Or is it a minor move in the market? Does it pull the pendulum back a little or a lot? What is your view on that?
KELLER: I think it pulls it back a medium amount. The specter of treble damages with the district court having wide latitude to decide whether they’re appropriate in any particular case—that could be meaningful, and it does ratchet up the risk for a defendant. For example, as we’ve seen in the wake of Octane, 285 awards have gone up a lot, which has definitely changed the risk calculus. And by definition, in almost every case the risk of treble damages is a lot scarier than the risk of attorney fees being shifted. So I do think that discretionary damage enhancements will go some way toward moving the pendulum to a more balanced place.
More important than that, let me just say as sort of a legal purist, I don’t care as much about the policy ramifications as I do about what the law is, and I think that the clearly correct interpretation of Section 284 is that it’s discretionary. It’s more discretionary even than Section 285. It just says that they “may be increased.” It doesn’t say in “exceptional cases” they may be enhanced or in cases where there’s “willfulness,” which is a word that the Federal Circuit invented. It just says they “may be increased,” period. That is as close to a complete grant of discretion as you’re going to get in a congressional statute. On the law, the patentees deserve to win.
QUINN: I agree with you on that. The only thing that scares me is that whenever I think I know exactly what the Supreme Court is going to do they seem to surprise me.
KELLER: You and me both. No one is truly good at playing the Supreme Court handicapping game. But more often than not, they take cases to reverse. If they wanted to just stand by the old standard, there was no reason for them to grant this case. The willfulness standard has been around for a while and the Federal Circuit has not laid any new ground on it, so if they didn’t want to reverse, it’s a strange case for them to have granted. They might still affirm, you never know. But my hunch is that they took it to reverse, and that’s the right thing to do.
QUINN: I agree with you on that. Now before I let you go, and I really appreciate you taking this much time to chat about this today, I want to ask you if you feel comfortable making some predictions. Looking forward into next year and beyond, what do you think the patent market has in store? Are you bullish on the patent market next year or over the next say three to five years, or are you be bearish? And then what level of confidence would you have in your prediction?
KELLER: I am mildly bullish, because we’re coming from such a low point that it is likely to improve from here. We just talked about the Supreme Court and the willfulness case. I also think that Europe’s unitary patent system is going to be an eye-opener, because it has the potential to be better than our system’s status quo. Competition is a healthy force, and the new system will drive innovation over there. People are going to pay attention to that, and as a consequence, it may improve things over here.
In Congress, after patent reform failed by a whisker last year this year, our team—actually, I shouldn’t use team metaphors, because I think the other side has some arguments that are worth taking into account, so I will say, the “pro-patent community” has been better organized. It has gotten its act together and done a much better job combating the claim that patents are a tool for dirty trolls, whatever that means, to extort value out of great corporate citizens that don’t deserve to have to pay patentees. Better pro-patent organization leads to some hope that, if there is patent reform, it will contain more good elements than bad elements.
Just because we’re coming from such a low place, and I think all of these factors are in the mix, I’m cautiously optimistic that we will improve from here next year and over the next two or three years.
QUINN: Okay. Well, great, Ashley, I really appreciate you taking the time to chat with me today.
KELLER: My pleasure. Thanks so much. And I look forward to seeing you in New York.
QUINN: Yes, I look forward to it as well.