[Digest Note] Insuring Patents

Patent Digest Note

Despite its increasing availability, patent insurance—providing defensive protection against claims of patent infringement and funding offensive actions against patent infringers—continues to be uncommon. This Note aims to provide an overview of the patent insurance landscape. After a brief discussion of the patent insurance industry in Part I, Part II describes how courts deal with patent infringement coverage under CGL policies. Part III examines the mandatory patent insurance scheme proposed by the European Commission and contrasts it with U.S. legislative inaction regarding patent insurance. Part IV explains why the U.S. system does not view patent insurance as a solution to the current patent litigation system through the lens of existing scholarship. Part V concludes.

Part I.  Overview

Historically, intellectual property insurance has been available for companies who wish to protect against the risk of injury, such as litigation costs, arising from intellectual property claims against them. This type of insurance can be traced to two early Commercial General Liability (CGL) policies developed by the Insurance Services Office (ISO) and used as standard forms in the insurance industry: (1) the 1976 introduction of “advertising injury” and “personal injury” by endorsement to ISO’s original 1973 CGL policy and (2) the 1986 incorporation of “advertising injury” and “personal injury” into “Coverage B” of CGL.[1]

Early policies provided limited coverage for intellectual property claims. The 1976 Endorsement’s “advertising injury” coverage included protection for injuries arising out of “piracy, unfair competition, or infringement of copyright, title or slogan” occurring “in the course of the named insured’s advertising activities,” but it excluded coverage for “infringement of trademark, servicemark, or trade name, other than titles or slogans, in connection with goods, products or services sold, offered for sale or advertised.”[2] The 1986 language redefined “advertising injury” to remove references to piracy, unfair competition, and trademark, and to provide coverage for injuries arising from one of four enumerated offenses: (a) publication of certain slanderous, libelous, or disparaging material; (b) publication of material that violates a person’s right of privacy; (c) “misappropriation of advertising ideas or style of doing business”; or (d) “infringement of copyright, title, or slogan.”[3]

Courts began taking a more generous approach in interpreting policy language under state law by recognizing the availability of coverage for IP claims under the “advertising injury” provision of CGL policies.[4] To determine whether the insured was covered, courts could use a standard three-step test: (1) whether the insured was “advertising” during the policy period; (2) whether the insured was potentially liable for one of the covered offenses; and (3) whether there was a causal connection between the injury from the alleged offense and the advertising.[5] As part of this process, courts interpreted key CGL policy language in ways that favored findings of insurance coverage. In particular, courts increasingly recognized coverage, or at least a valid legal claim, in defending trademark infringement[6] and trade dress infringement[7] suits under CGL policies. Since these early CGL policies expressly included copyright infringement as a covered offense under their “advertising injury” provisions, courts were more ready to recognize copyright infringement coverage as well,[8] even when the causal link to advertising was arguably weaker.[9]

Against this backdrop, ISO revised its CGL policy in 2001, expressly limiting coverage for intellectual property claims. The 2001 ISO CGL policy updated the 1986 policy’s “misappropriation of advertising ideas or style of doing business” by removing “style of doing business” and modified “infringement of copyright, title, or slogan” to clarify the offense as “infringing upon another’s copyright, trade dress, or slogan in your advertisement.”[10] These developments appear to follow a typical pattern in the insurance industry. First, courts attempt to stretch existing insurance policy language to fit an unforeseen risk. Second, insurers respond by revising insurance policies to exclude the risk. Finally, insurers develop new policies to deal with the specific risk.[11]

Since courts were generally reluctant to find coverage for patent infringement claims in particular under the CGL’s “advertising injury” provision,[12] companies have sought alternative approaches to insuring their patents. For example, parties to the insurance contract can execute an endorsement adding “patent infringement” to the list of offenses under the “advertising injury” coverage in the CGL policy.[13] A separate and specialized insurance market for intellectual property has also developed to cater the need of companies to protect their technological innovations or prevent them from excessive damages due to their infringement of others’ IP rights. These insurance policies can sometimes provide very specific protection, such as a product which insures against the risk of patent trolls.[14]

Patent insurance can fall into two categories: patent infringement insurance and patent enforcement insurance. Patent infringement insurance funds defensive efforts against allegations of patent infringement; it is also known as defensive patent insurance. Patent enforcement insurance funds enforcement actions against those who infringe against a firm’s intellectual property; it is also known as offensive patent insurance, abatement insurance, or a pursuit policy.[15]

Patent infringement policies generally cover infringement stemming from the use, distribution, sale, and advertising of the patent.[16] These policies usually cover attorney’s fees, settlement payments, prejudgment interest and damage awards and they may be limited territorially to the United States.[17] Meanwhile, patent enforcement policies generally cover legal expenses for enforcing patent rights against infringers.[18] Such policies usually include the following terms: (1) the alleged infringement must occur during the period of coverage; (2) the patent covered must be specified; and (3) coverage does not extend to those licensed to use the patent.[19]

A company’s insurance strategy differs depending on its industry and its type. For example, large pharmaceutical companies may be worried about infringement of their patents by generic companies, rather than the risk that they themselves are infringing others’ patents.[20] This structure will incentivize the pharmaceutical companies to purchase patent enforcement policies instead of infringement policies.

However, despite the fast-paced legal development of intellectual property insurance in general, for a long time, patent insurance has not seemed to have gained much support from companies holding patent assets. In a 2003 report, CJA Consultants Ltd. observed that patent insurance “has not been successful throughout the world.”[21] The existence of patent insurance might give a company an upper hand in litigation,[22] but most companies are not yet ready to purchase patent insurance to counterbalance their intellectual property risks. In addition, given the increasing upward-trend of patent litigation in the U.S., some commentator urges insurance companies to respond by working with their clients to innovate patent insurance.[23] Recently, along with the European Union’s creation of the Unitary Patent system[24] and related discussions, it seems that a somewhat centralized patent insurance system is likely to offer some benefits to the unifying European market.[25] The European Union has long discussed about a mandatory patent insurance scheme to cover the IP risks faced by Small and Medium Enterprises (“SMEs”), which forms a sharp contrast with the resistance to a centralized insurance scheme in the United States.

Part II. Coverage of Patent Infringement under CGL Policies

Courts have not generally interpreted CGL policy language to provide coverage over patent infringement claims. The basic rationale is explained in Iolab Corp. v. Seaboard Sur. Co., a 1994 case from the Ninth Circuit. In the underlying suit, a patent owner had sued Iolab, a lens manufacturer, for patent infringement, and the district court found Iolab liable.[26] Prior to the damages phase, Iolab raised a defense based on 35 U.S.C. §271(e)(1), arguing that it had been authorized to sell the patented product because it was for research and FDA approval purposes.[27] The patent owner disagreed, citing Iolab’s extensive marketing and advertising campaigns as evidence that Iolab’s motive was financial and fell outside the §273(e)(1) exemption.[28] The parties settled for $13.5 million.[29]

Iolab, as plaintiff, then sued defendant insurers for indemnification under policy language similar to the 1976 CGL Endorsement, and the defendants refused to pay.[30] According to Iolab, the “advertising injury” provision applied because its losses from the underlying patent suit were caused by the advertising campaign that removed the protections of §273(e)(1).[31]

The District Court disagreed and granted summary judgment motions or dismissals in favor of the defendant insurers.[32] The Ninth Circuit affirmed and explained:

In the context of policies written to protect against claims of advertising injury, “piracy” means misappropriation or plagiarism found in the elements of the advertisement itself—in its text form, logo, or pictures—rather than in the product being advertised. Iolab’s claims of piracy arising out of advertising has no basis because [the patent holder’s] claim was based on Iolab’s infringement of his patent for the intraocular lens itself rather than on an element of Iolab’s advertising of the lens. While patent infringement can be piracy of the advertised product, generally it is not piracy of the elements of the advertisement itself.[33]

Interestingly, the above reasoning in Iolab Corp. left the possibility of patent coverage under a CGL policy when patent infringement is “piracy of the elements of the advertisement itself.” Several courts have since employed this rationale to find that the insurer had, at minimum, a duty to defend[34] in an insured’s underlying patent suit. In Amazon.com Int’l, Inc. v. Am. Dynasty Surplus Lines Ins. Co., the Washington Court of Appeals concluded that an insurer had a duty to defend under the “advertising injury” provision in a patent infringement suit because the insured’s allegedly infringing music preview technology was an element of its advertisements; the patent infringement “occurred in the advertising itself.”[35] Similarly, the Tenth Circuit, applying Colorado insurance law and citing Amazon favorably, reversed a district court’s grant of summary judgment in favor of defendant insurers and found a possible duty to defend under an “advertising injury” provision where the alleged infringement included telephone technology that the insured used to sell its products.[36] However, absent the narrow situation where the advertising means itself is patented, or the parties add patent infringement as an enumerated offense,[37] courts appear reluctant to find coverage for patent infringement claims under the CGL “advertising injury” provision.[38]

Courts have also been reluctant to find coverage even when a party tries to recast a patent infringement claim under other provisions in a CGL policy. For example, the Tenth Circuit held that a claim of patent infringement was not “invasion of possession of personal property” within the scope of a CGL policy.[39] Similarly, the Ninth Circuit held that an underlying patent infringement claim was not a “personal injur[y]... arising out of... oral or written publication of material that... disparages an organization’s goods, products or services.”[40] Such reluctance can also be seen when underlying patent dispute has an international dimension. In 2006, the U.S. Court of Appeals for the Second Circuit rejected a respondent’s insurance coverage argument relating to an International Trade Commission proceeding, holding that there was no coverage for “disparagement” of goods or services because a catalog listing the products did not assert specific unfavorable facts relating to the patent or products that were infringed.[41]

It is clear that from the development of CGL policy language, particularly in light of the modifications in 2001, and the courts’ consistent interpretation rejecting patent infringement coverage, that a standard CGL policy is unlikely to afford companies protection in patent litigation. In light of the CGL’s limited protection for patent infringement, one way to secure coverage would be to amend the CGL policy to provide coverage for patent infringement, such as through an endorsement. However, purchasing extra coverage for patent infringement on top of a complete CGL policy might be economically burdensome for (1) technology-centered companies, whose main assets are their intellectual properties; and (2) SMEs which cannot afford comprehensive insurance for their patents. Thus, developing a specialized patent insurance market seems essential to insuring the risks associated with patents. The remaining parts of this Note will thus discuss the development of such specialized patent insurance policies.

Part III.  The EU Mandatory Scheme Discussion and U.S. Inaction

In 2002, the European Commission commissioned CJA Consultants, Ltd. (“CJA”) to analyze the need for, and the feasibility and implications of, introducing possible insurance schemes against cost for litigation in patent cases at the European level. In 2003, CJA presented a study on patent litigation insurance (“PLI”), concluding that “the use of PLI was less than anticipated, but that the potential demand was large.”[42] In January 2006, CJA published another report detailing the feasibility of a patent insurance scheme targeting SMEs in Europe, arguing, inter alia, that “only a mandatory scheme can provide the economic and technical benefits to the EU and individual patentees which would arise from a widespread scheme,” and the insurers can only be willing to get involved when the insurance market is on a scale.[43] It also concluded that it is possible to move back to a voluntary scheme later once a mandatory scheme is well-established.[44]

       This report triggered immediate responses from stakeholders. According to a summary report on stakeholders’ reaction to the study’s conclusions in 2007, all twenty-eight responses to the study’s proposed mandatory insurance scheme are somewhat negative. None of those responses supported the proposed insurance scheme.[45] In fact, only two responses supported the idea of a mandatory system, but not the system as proposed.[46] Respondents voiced a variety of oppositions. Some stakeholders argued that “insurance cover pushe[d] the balance towards litigating rather than settling an infringement dispute.”[47] Some voiced the concern that “foreign ‘patent trolls’ could be encouraged to enter the European market and take legal action against alleged infringers of unexploited, often trivial patents” since the proposed schemes “fore[saw] defence cover and [were] available for patentees from non-European countries.”[48] Some stakeholders considered the proposed level of premiums too high; some viewed such a mandatory scheme as extra tax; some maintained that such a scheme would discourage SMEs from using European patents; some feared that the manufacturers SMEs would have to face additional costs for patent clearance searches; and some were concerned about the increase of administrative burden on national patent offices.[49] Given the widespread opposition, the mandatory patent insurance scheme was aborted at that time.

       However, the idea of a patent insurance scheme has recently resurfaced in the European Union discussion. With the introduction of the Unitary Patent system and the establishment of a centralized Unified Patent Court, the E.U. has made a firm step towards a single unified market.[50] In the endeavor to consolidate Europe’s IP framework, staff re-discussed the possibility of a patent insurance scheme.[51] Similar to the previous discussion, the IP risks disproportionately faced by SMEs were a major concern for introducing a “functioning IP litigation insurance market.”[52] The IP insurance market is also envisioned to remedy the losing party’s litigation costs under the Unified Patent Court. In the working document accompanying the Commission report, the Commission explained:

  The cost exposure for IP rights and particularly patent litigation is significant, hits SMEs disproportionately hard and acts as a serious deterrent for SMEs to engage in patenting in the first place. Indeed, under the Unified Patent Court, firms that lose a legal dispute will have to pay the court fees of the winner (provisionally estimated at a fixed fee of EUR 11,000 plus a value based fee of up to EUR 220,000). . . In addition, the losing party will typically also be required to pay damages. Such exposure can only be effectively addressed through a functioning IP litigation insurance market . . . An insurance scheme would not only counter the risks of such legal fee exposure: the security of insurance and the possibility of a valorization of IP assets could in turn lead to more investment by banks and other financial institutions into innovative start-ups and SMEs.[53]

Some commentators interpreted this language as a point made by the European Commission that SMEs will need IP litigation insurance.[54] Although it seems uncertain from the above language whether this proposed scheme of patent insurance will be mandatory, it is clear that the European Commission is still considering the possibility of a patent insurance scheme at a regulatory or legislative level.

In contrast, U.S. legislators and regulators have been comparatively less active in implementing a patent insurance scheme. In the process of notice and comment to the June 2006 study, the American Chamber of Commerce to the European Union, an organization in Europe representing the views of American companies, expressed serious concerns over such a mandatory patent insurance scheme, claiming such a scheme would discourage SMEs from innovating by imposing too much cost, and encouraging U.S.-like disruptive patent litigation.

The American Chamber of Commerce to the European Union might represent a wider consensus among the U.S. patent players that a mandatory patent insurance scheme will fail. For example, one commentator argued the above EU-mandatory patent insurance proposal, if applied in the U.S., would suffer from the industry’s “negative network externalities”[55] and existing failures in the U.S. insurance system.[56] The commentator noted that such a scheme does not propose workable criteria for determining the minimum standards for the coverage limit, deductible, and coinsurance, increases initial costs for start-up companies that use patents, and add additional administrative burdens to the already overworked USPTO.[57]

U.S. scholars’ resistance of a mandatory patent insurance scheme is quite predictable in light of the nation’s overall lack of an attempt to introduce a similar scheme into the patent system. In contrast to the active role undertaken by the European Commission, the U.S. legislature, though consistently preoccupied with patent reform bills that have largely floundered at the hands of interest groups, does not seem to consider patent insurance as a reliable solution to existing patent litigation problems. According to Intellectual Property Owners Association, just in 2015, at least five bills related to patent litigation reform were introduced in the 114th Congress and referred to either the Committee on the Judiciary or the Committee on Energy and Commerce.[58] Such legislative efforts are evidence of consistent preoccupation with the existing patent system in the past few years.[59] Such endeavors to reform the existing patent litigation scheme can also be seen in the academy. Early in 2015, fifty-one scholars in the field of economics and law submitted a letter to the U.S. Congress, petitioning for effective legislative reform to reduce patent litigation costs.[60]

       Despite such extensive efforts targeting patent reform, the word “insurance” rarely appears in the texts of the bills. In the places where it appears, it is used to define other terms instead of having any significant connotation of employing patent insurance as a means to reform the existing patent system.[61] It shows that the U.S. Congress either has not explored the possibility of using patent insurance to tackle existing problems in the patent system, or has concluded that patent insurance would not be an alternative to the current problems afflicting the patent system. Given the lack of discussion on patent insurance, it seems more probable that the U.S. Congress has not yet studied the tool of insurance as a potential cure for the current patent system. State legislation appears equally lacking. In Florida, for example, legislation has merely acknowledged the existence of patent insurance rather than using it as a mechanism of institutional reform.[62] Such inaction, in contrast with the more active role undertaken by the European Commission, might be explained by a prevalent disbelief in patent insurance as a means to solve the current problems embedded in the patent litigation system. The next Part discusses the current suspicion among U.S. scholars on the proposed patent insurance system.

Part IV. The U.S. Suspicion against Patent Insurance

Critics have been quite suspicious about the effectiveness of insuring patents since its initial appearance. In his 1995 note, Jason A. Reyes reached the conclusion that patent insurance provided only a limited solution to the risk of infringement and could also lead to expensive litigation.[63] In particular, when discussing patent infringement insurance, Reyes posited that the ambiguity of the policy language might not incentivize companies to view litigation or arbitration as a solution to their perceived risk:

More importantly, the coverage may not give companies the protection they need. Most companies will not view expensive insurance litigation or arbitration as a solution to their perceived exposure to infringement actions. As in other areas of insurance disputes, the policy . . . contains terms that are sufficiently ambiguous to litigate at length in court or arbitration. Ambiguous terms include when the claim was made, whether the claim was reported as soon as practicable, whether a particular expense was a defense expense, whether the claim arose from pending litigation or litigation prior to the policy’s effective date, and whether the insured had knowledge of an upcoming claim prior to the policy’s effective date . . . . [64]

With regard to patent enforcement insurance, Reyes concluded that it entailed similar problems, but “enough money may be available to keep the insurer interested because the insured and the insurer are both potential beneficiaries of a large damage award.”[65] However, such aligned interest does not seem to aid a prosperous insurance market, and the author was still suspicious towards how insurance can assist companies to ameliorate patent risks.[66]

The above conclusion invites further debates among patent insurance scholars and practitioners. One of the fundamental premises of the above note is that the insured can only passively decide whether or not to purchase patent insurance and whether to pursue litigation when a lawsuit is filed. Some research has suggested that the above premise may not necessarily be true. For example, an empirical study in 2011 shows that it is possible to predict patents that end up in litigation.[67] The author randomly selected 659 patents issued in 1990 and three additional patents issued in the same year assigned to the same first-listed technology class, creating a matched-pair set that included 2,636 patents.[68] The research found that the most litigated patents can be predicted based on the economic value of the patent, the characteristics of the owner of the patent, and her propensity to litigate.[69] This empirical study shows the possibility that the insured can adversely select their higher-risk patents ahead of time based on the above criteria, and thus minimize their potential litigation costs.[70]  One may argue that this adverse selection would lower the high premium companies have to pay in total for their patents. However, not only does the empirical study not offer a workable scheme to calculate the risks associated with patents to be litigated, but also the actual premiums might be raised if companies can adversely select patent insurance.

       Difficulty in developing a sound patent insurance market suggests the intricate nature and the inherent uncertainty of patent law, and the accompanying difficulty of seeking insurance for patents. Professor Kelly Mullally identifies two systemic sources of such uncertainty: uncertainty that results from patent law’s public institutions and uncertainty that results from private actors in the patent system.[71] With regard to the public pressures, Mullally concludes that four public institutions – the USPTO, U.S. district courts, the Federal Circuit, and the Supreme Court – have different preferences and needs regarding the form of patent rules.[72] While the USPTO and district courts have pressure to form clear-cut rules, the Federal Circuit and the Supreme Court move the law away from formal rule-like doctrine.[73] With regard to private pressures, patent applicants have incentives to introduce uncertainty into their patents,[74] and thus invite uncertainty into the patent system as a whole. The unique characteristics of the patent system makes insurance particularly difficult:

In many other areas of the law involving civil suits, such as torts, insurance protects against the risk of loss, thus limiting liability and making clear an insured’s potential exposure, even in the face of unclear legal doctrine. In patent law, however, neither liability nor litigation-expense insurance is readily available. Even in the rare circumstances where coverage is offered, prospective patent litigants rarely purchase it due to high premiums, conservative underwriting, and undesirable policy limitations.[75]

Thus, Prof. Mullally’s paper seems to suggest that the existing U.S. patent litigation system does not support the development of a sound and workable patent insurance market. Given the scale of a company’s patent portfolio and the high premium to be paid for the patents, companies seem to be fully justified economically not to purchase patent insurance. As mentioned above, even assuming that companies can adversely select to-be-litigated patents, the insurance market might also quickly respond to such structural change. Unlike natural disaster insurances, neither the insureds nor the insurers in the patent market can be certain about the chances and allocations of patent-associated risks. Thus, it seems that the U.S. patent insurance still has a long way to go to qualify as a means to effectively protect innovations.


Part V.  Conclusion

This Note presented an overview of patent insurance landscape in current scholarship. It concludes that the CGL policy will not provide strong protection for patent infringement, and companies will need to seek special patent insurance for their technological assets. However, the patent insurance market is yet to mature both in Europe and the U.S. In light of the high costs associated with patent litigation, the European Commission has taken a more active role at a legislative or regulatory level to study the implications of a mandatory patent insurance scheme, whereas the U.S. has seldom taken action on a legislative or regulatory level. Such inaction shows a prevalent suspicion towards patent insurance’s effectiveness and efficiency. However, given the prohibitive costs of intellectual property litigation, Congress should consider insurance as a potential policy alternative to regulate the industry on the basis of thorough studies and feasibility analysis.