January 1, 2011, 12:00 AM

Defusing the patent bomb

Facing a growing number of lawsuits over patents, e-retailers seek ways to prevent losses that can run into millions.

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Call it a $2.5 million—and rising—potential time bomb.

That’s the amount Newegg Inc. was ordered to pay last April by a jury that decided the online retailer had infringed on three patents owned by Soverain Software LLC that cover such web applications as shopping carts. Though other e-retailers decided to settle and pay up, Newegg, exhibiting a stubbornness that is privately admired by many in the industry, appealed the decision.

In August, however, a federal judge in the Eastern District of Texas, Leonard Davis, upheld the jury verdict. The Texas court also awarded Soverain post-verdict damages of $2,900 per day from May 1 until the date of the final judgment, more than $1 million a year for as long as the case drags on. Still, Newegg fights on, even though legal fees in such cases can be more than double the damages awarded to patent holders. The consumer electronics retailer in early December appealed the decision to the U.S. Court of Appeals for the Federal Circuit, based in Washington, D.C.

“We intend, if necessary, to take this case to the U.S. Supreme Court,” says Newegg chief counsel Lee Cheng. He is hoping what he sees as a pro-business court will favor an operating business like Newegg over what he and others call “patent trolls”—companies created to buy up, and collect upon, patents dealing with fundamental technology that serves as the spark plugs, pistons and batteries of e-commerce sites. “What drives us is we want to give the best online shopping experience possible to consumers instead of giving money to companies that add no value to society.”

Such a statement may smack of sloganeering, but it’s an argument often expressed by online retailers large and small: The so-called patent trolls, by buying up patents for inventions created by others, and then demanding a cut of revenue or licensing fees from e-retailers, suck money from companies that actually sell tangible products. The patents often stem from technology first committed to paper in the early or mid-1990s, near the dawn of e-commerce, and which now is woven into the web infrastructure of many retailers.

A few retailers privately say that they never bothered to dig too deeply into the intellectual property origins of the software they used to build their e-commerce sites—including during the Internet’s adolescent growth spurt of the late 1990s—because so many other web merchants were using virtually the same technology. “It’s impossible to know without immense time and money,” says an executive of one Top 500 retailer. “E-commerce operators want to be in blissful ignorance.”

That means patents can represent time bombs for online merchants, who never know when or if the explosives will go off. In fact, more patent holders have pressed the trigger in the last few years, often suing many online retailers at a time, and forcing web merchants to rethink how they defend themselves.

A better mousetrap

For now, most online retailers, facing the prospects of millions of dollars in legal fees to defend against infringement claims, tend to settle. And they often keep quiet about the settlements, either because of non-disclosure agreements, fear of attracting more infringement claims, or both. Despite the high-profile fights against infringement claims by such e-retailers as Newegg and Overstock.com Inc., most e-retailers remain inclined to settle.

“In the near term it will get worse,” says an executive for another company in the Internet Retailer Top 500 Guide who did not want to be named because his company has settled a patent claim and hopes to avoid more attention from patent-holding companies. “I think this is a nightmare waiting to happen for retailers.”

More retailers are likely to face the threat as online shopping becomes ever more mainstream and ever more profitable, because patent holders can claim larger damages. As well, patent law and retailing experts say patent holders are shifting their tactics to target more companies in hopes of gaining smaller but more numerous settlements instead of going after windfalls from fewer firms. In fact, the average number of defendants in patent cases stood at 7.6 in the first quarter of 2010, up from 4.4 from the same period in 2009, according to RPX Corp., a firm that buys patents to protect its clients against infringement claims.

Online retailers, though, have some reasons for optimism: Clauses in vendor contracts regarding e-commerce technology can provide at least a paper line of defense against infringement claims, and some retailers have shown a willingness, via briefs filed in cases involving competitors, to stand together against patent holders. As those companies continue to pursue infringement claims, one of the best hopes for retailers could be further efforts to band together in common defense, some experts say.

“The Internet retailers need to start thinking about how to approach this problem proactively,” says Peter Brann, a partner with Lewiston, Me.-based law firm Brann & Isaacson, who has defended e-retailers against patent infringement claims. “We need a better mousetrap, because the one we have right now isn’t working.”

RPX says the volume of cases filed by patent trolls—or, more politely, non-practicing entities—since 2001 has increased nearly 400%. While it is difficult to say exactly how many apply specifically to e-commerce, some recent filings give a glimpse of the scope of the danger for retailers.

Early last year Interval Licensing LLC, an Internet technology firm backed by Microsoft Corp. co-founder Paul Allen, filed infringement suits against 11 web companies, including such online retailers as Apple Inc., Netflix Inc., Office Depot Inc., OfficeMax Inc. and Staples Inc. Interval claims the companies violated four patents related to site search, including one “for a browser for using and navigating a body of information,” and three related to “categorizing, comparing and displaying segments of information.”

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