Hedge funds and institutional investors are financing the latest wave of IP lawsuits.
DeepNines is a tiny Dallas software maker that protects corporate computer networks from hackers and other threats. But in August it became an attacker, filing a lawsuit against McAfee. The suit alleges that the security-software giant infringed on a DeepNines patent, one that combines an intrusion detection and prevention system with a firewall, in a single device. McAfee denies the charge, saying the patent relies on previously known technology, and is gearing up for a long and costly fight.
But DeepNines has found a way to fund its burgeoning legal bills. In January it sold an $8 million zero coupon note to Altitude Capital Partners, a New York City private equity firm, promising in return a cut of any winnings stemming from the lawsuit. The payout is based on a formula that grants Altitude a percentage that decreases with a bigger award.
This deal was dreamed up by Robert Kramer, who founded Altitude in 2005, raising $250 million from hedge funds and others to invest in intellectual property. So far Kramer has put $100 million to work in nine investments. He’s got plenty of company in this new game. Coller Capital, a London private equity firm with a $2.6 billion fund, quietly formed Coller IP Capital with an eye toward investing $200 million a year. Rembrandt IP Management, a Bala Cynwyd, Pa. firm, has raised $150 million, and Northwater Capital, a $9 billion Toronto manager of funds of hedge funds, put together NW Patent Funding last year. Both exist solely to exploit patent lawsuits in the U.S.
Sounds a lot like patent trolling, a much-vilified practice in which contingency lawyers or small companies with no operations sue businesses to extort money. But funds like Altitude insist they’re asserting legitimate claims. "I don’t get emotional about this issue," says Kramer, who used to be a managing director at a Fortress Investment Group hedge fund. "I am a financial investor."
It’s not easy to make a buck. Last year the Supreme Court limited the ability of small outfits in patent cases to get injunctions against large companies. Meantime, there’s a proposal by Democrats in Congress for patent reform legislation, backed by the likes of Intel and Microsoft, that would put an end to triple-infringement damages. But the new funds are still tempted by huge verdicts such as Alcatel-Lucent‘s $1.5 billion patent victory over Microsoft in February and NTP’s $612 million settlement with Research in Motion. Says Daniel McCurdy, a patent consultant in Warren, N.J., "They are the arms merchants in the new patent wars."
The threat of war is having an impact. Ebay subpoenaed Altitude in federal court in Virginia to figure out what Kramer is up to with one of his investments, MercExchange, whose main asset is a $25 million patent infringement verdict against the online auctioneer. The six-year-old suit claims Ebay’s "Buy It Now" feature infringes on MercExchange’s patents. Last year the case produced the Supreme Court decision that made it more difficult to get injunctions.
Kramer is also shaking up the world of wireless. In January he invested $35 million in Visto, a Redwood City, Calif. maker of software for wireless e-mail that has sued Microsoft, Research in Motion and a unit of Motorola in federal court in Marshall, Tex., a jurisdiction known for big patent paydays. The tech companies all deny infringing on the patents. But moneylosing Visto won $7.6 million in damages in its first victory, in December, against Seven Networks, a small competitor. "The precedent set with the Seven case will replay itself with anybody else who chooses to see this through litigation," warns Visto Chief Brian Bogosian.
Paul Schneck has a more audacious plan, buying up patents and launching suits from scratch. A computer scientist who once worked for the National Security Agency, the U.S. Navy and NASA, Schneck heads up Rembrandt IP Management. His $150 million war chest has helped him pick up 200 patents; he is currently suing 15 companies and plans to go after more. "We are focused on obtaining jury verdicts," he says. "That’s why we put our own money at risk, all the way from acquisition through appeal."
First target: the cable industry. In 2004 Rembrandt spent $1 million for a patent portfolio from Paradyne, once a unit of Lucent Technologies, in order to challenge the most fundamental part of the cable business: how cable companies and TV networks receive and transmit digital broadcast signals. It has sued Comcast, Time Warner, Walt Disney‘s ABC and others, all of which deny any infringement. Some defendants claim the technology was set by a group that included AT&T, which agreed in the early 1990s not to assert any patents and to license them for a reasonable fee. "The patent system is designed to allow people to protect the fruits of their invention," says Daralyn Durie, a lawyer for Comcast. "But this seems to be a perversion of what the system was designed to accomplish."
Schneck is also going after the vision business, laying claim to the treatment of contact lens surfaces, which determines the gas permeability of soft contacts. He bought the patents from inventor Sing- Hsiung Chang and last year sued Bausch & Lomb and Novartis‘ Ciba Vision unit. Both companies say that Chang didn’t invent the technology. But Schneck has them seeing double–and tied up in court for years.