Explaining Efficient Infringement

By Adam Mossoff & Bhamati Viswanathan

In a recent New York Times op-ed, “The Patent Troll Smokescreen,” Joe Nocera used in print for the first time the term, “efficient infringement.” This pithy phrase quickly gained currency if only because it captures a well-known phenomenon that has been impossible to describe in even a single sentence. Unfortunately, some commentators are confused about the validity of this term. This is understandable, because no one has yet described exactly what it means, especially in comparison to the similar commercial practice of “efficient breach” in contract law.

In a nutshell, efficient infringement occurs when a company deliberately chooses to infringe a patent given that it is cheaper than to license the patent. The reason it is cheaper is what makes it hard to explain briefly: a slew of legal changes to the patent system by Congress, courts, and regulatory agencies in the past ten years have substantially increased the costs and uncertainties in enforcing patents against infringers.

Accused infringers now can very easily invalidate patents, either in court or at the “patent death squad” known as the Patent Trial and Appeal Board. If a patent owner runs this gauntlet after several years of costly litigation and obtains a judgment in its favor, courts are increasingly refusing to award injunctions for anyone other than manufacturing companies. What is left for the patent owner is only damages, but changes in the legal rules for awarding damages have made damage awards very minimal compared to the actual economic harms suffered by a patent owner (a 2015 PricewaterhouseCoopers study found that median damage awards in 2014 were at their second lowest level in the past 20 years).

The result of all of this is that a company economically gains from deliberately infringing patents. It pays less in either legal fees or in court-ordered damages than it would have paid in a license negotiated with a patent owner. This is efficient infringement.

As a term in the legal policy debates, efficient infringement draws some inspiration from the well-known economic model of “efficient breach” in contract law. But the two seem very different, at least superficially.  Thus, efficient infringement needs further explanation by way of a more explicit comparison to efficient breach theory.

The model of efficient breach posits an overall net gain in social welfare from a willful breach of contract. It supposes a scenario in which one contracting party has an opportunity to obtain a higher payment for its goods or services, producing a profit that exceeds any damages from a breach of contract that would be paid to the other contracting party. Thus, the contracting party breaches: it receives the higher payment, it pays the other contracting party its “expectancy interest” (lost profits), and it pockets its net profits. Everyone wins and society is better off, at least according to this highly stylized and abstract economic model.

In practice, though, one rarely finds cases in which this opportunistic breach of contract works. The losses suffered by a victim of a breach of contract easily exceed mere profits, and courts account for this by awarding reliance and restitution damages, as well as punitive damages for deliberate misconduct like opportunistic breach of contract. Other legal claims, such as tortious interference with a contract and equitable claims for rescission and restitution, provide additional sources of relief for victims of willful breaches of contracts. In fact, one reason contracting parties negotiate liquidated damages provisions in their agreements is to limit liability for these widely recognized costs that go beyond mere expectancy interests.

These additional damages reflect the total costs created by strategic, opportunistic breaches of contract. These include institutional and systemic harms in eroding reasonable reliance on contractual commitments, lost investments made on the basis of contractual commitments, lost opportunities to pursue other commercial transactions, reputational harms, and so on. A victim of an opportunistic contract breach, for example, can seek the equitable remedy of rescinding the contract and seek restitution to disgorge the willful bad actor of his wrongful gains at the expense of the victim.

This is why one usually finds successful efficient breach only in hypothetical examples in economic textbooks or in law review articles, and not in actual court cases. As one of the scholars who first coined this term in 1977 recently observed, “efficient breach is both a null set as well as an oxymoron.” Or, as Professor Gregory Klass similarly notes, efficient breach is a “dead letter,” although he still believes it “remains a great teaching tool.”

Recognizing this difference between theory and practice is key in understanding the parallels between efficient breach and efficient infringement.  In theory, efficient breach considers only the lost profits in a one-off case of contract breach, and it thus sounds like a gain in social welfare because everyone benefits. But, in practice, contracting parties and courts recognize the total individual and systemic costs caused by willful violations of legal rights, whether a contract right or a property right. The same is true for efficient infringement, in both theory and practice.

Theoretically, efficient infringement posits a breach of a legal right that enhances both private and social welfare. The company benefits privately because it pays less via a patent infringement lawsuit in either legal fees (invalidating the patent) or in a compulsory license (court-awarded damages). Society is better off, too, because the company engaging in efficient infringement has more resources to put to productive endeavors, as opposed to paying for use of an invalid patent (a monopoly) or in making a larger wealth transfer payment on the basis of a negotiated license.

In the real world, though, efficient infringement creates more costs than merely the lost licensing profits for the patent owner, or the lost patent itself. The more fundamental problem with efficient infringement is that it undermines the proper functioning of the patent system. It frustrates the promise of the reward to the innovator for one’s inventive labors. Once inventors know that the deck of (legal) cards is stacked against them and that they will suffer efficient infringement, they will create less patentable innovation. Without legal security in stable and effective property rights, venture capitalists will not invest in inventors or startups and the innovation economy will suffer.

The important point is that these negative dynamic efficiency effects from efficient infringement are systemic in nature. This is similar to the concern about systemic costs represented by such causes of action for willful breach of contract as restitution and disgorgement of wrongful gains. As a matter of real-world practice, the costs created by efficient infringement are similar to the broader private and systemic costs created by opportunistic breaches of contract—both threaten the viability of legal institutions and the policies that drive them, such as incentivizing investments and promoting commercial transactions.