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How Do Economic Downturns Affect Patent Litigation?

By Peter Zura

In the arena of patent litigation, two competing theories attempt to explain how the macroeconomic environment influences motives to file suit. On one hand, the decline in revenues associated with falling demand encourages firms to reduce litigation in IP suits as a method of reducing costs and maintaining profitability.  On the other hand, the very decline in profits spurs firms to extract greater revenue from dormant assets by litigating more aggressively against perceived infringers.  In other words, the relative rate of return on investing in patent litigation rises during downturns, thereby making it more attractive as a business strategy.

Until now, there has been no systematic study of how macroeconomic conditions affect the rates of patent litigation.  Alan Marco & Ted Sichelman recently took on the task of analyzing this topic and have published their findings in a paper titled "Do Economic Downturns Dampen Patent Litigation?"

In general, Marco and Sichelman found that patent litigation rates may rise or fall following an economic decline depending on the relative shifts in macroeconomic factors driving the downturn. For example, economic declines characterized mostly by drops in GDP, but for which credit remains freely available, are associated with increases in patent litigation rates. On the other hand, declines characterized by the converse situation - as in the current recession - are associated with decreases in litigation rates.

Until the study undertaken here, practicing attorneys disputed whether economic downturns increased or decreased patent litigation rates. One camp - relying on data from all but the current recession - argued that downturns increased litigation, because the rate of return from patent litigation increased relative to selling products and services. In other words, litigation substitutes for traditional sales during downturns. Another camp - emphasizing litigation declines in the current recession - contended that capital constraints present in downturns reduce overall litigation rates.

In the first study of its kind, we resolve this debate by showing that both theories are very likely correct. Specifically, declines in GDP and the NASDAQ index are associated with significant increases in overall patent litigation. This result provides support for the substitution theory. In contrast, increases in the TED spread, a measure of macroeconomic financial risk, as well as T-bill rates are associated with declines in overall litigation rates. This finding supports the capital constraint theory. As such, our study indicates that overall patent litigation rates may rise or fall depending on the nature of the economic downturn. When productivity declines and decreases in sales dominate capital effects, litigation will tend to rise, and vice-versa.

Read/download "Do Economic Downturns Dampen Patent Litigation?" via SSRN (link)

Full post as published by Two-Seventy-One Patent Blog on August 10, 2010 (boomark / email).