November 20, 2014

FTC Settles First "Patent Troll" Consumer Protection Action

5 min

On November 6, 2014, the Federal Trade Commission (FTC) announced the settlement of its first action against a "patent assertion entity" (PAE), also known as a "patent troll," for employing deceptive sales claims and fraudulent legal threats in demand letters to thousands of small businesses. The PAE is MPHJ Technology Investments LLC (MPHJ), a company in the business of acquiring patents in order to assert infringement claims and garner licensing fees. Although many companies engage in "troll-like" business practices, MPHJ is among the most notorious and aggressive. Despite having only one member, owner Jay Mac Rust, MPHJ has allegedly sent out demand letters from dozens of shell companies to more than 16,000 small businesses over the last two years. Even before the FTC's investigation became public, several state attorneys general had already launched investigations into MPHJ's practices and filed suit under state consumer protection laws, which are still ongoing. MPHJ's practices also fueled support for legislation to protect small businesses from patent trolls' predatory practices.

According to the FTC's administrative complaint, MPHJ purchased five patents on networked scanning systems in September 2012. Soon after, the company began sending out demand letters to small businesses, alleging that they were infringing MPHJ's patents and soliciting them to purchase licenses. Using business directory databases, MPHJ specifically targeted companies having between 20 and 99 employees, in particular types of industries, such as veterinary services, gardening, and medical laboratories. MPHJ also entered into an agreement with the Texas law firm Farney Daniels PC, under which Farney Daniels agreed to represent MPHJ in relation to asserting and monetizing the patents, in exchange for a percentage of any licensing fees MPHJ obtained.

According to the FTC, MPHJ employed a "three-stage campaign to promote and sell licenses," consisting of three letters sent to a business over a period of months. Using the letterhead of one of MPHJ's dozens of shell company subsidiaries, followed by letters from Farney Daniels, MPHJ allegedly would represent that "most businesses…are interested in…taking a license promptly," and that "a fair price for a license" was "a payment of $1,200 per employee." Finally, MPHJ would threaten to sue for patent infringement if the recipient did not respond within two weeks. The third letter was accompanied by a document, purportedly the draft complaint that would be filed if the recipient did not respond. The letters, as well as the draft complaints, were essentially identical across all targeted recipients. In spite of its threats, MPHJ never filed a single complaint against any of the more than 16,000 small businesses targeted by the letters, according to the FTC.

Because of these practices, MPHJ became the first PAE against which the FTC has taken action under its consumer protection authority. After discovering that it was the target of an FTC investigation, MPHJ filed its own suit against the FTC in January 2014 as a "preemptive strike," naming four FTC commissioners and claiming that the agency was "violat[ing] the [First Amendment] rights of MPHJ and its counsel under the U.S. Constitution." MPHJ argued that sending the demand letters was a "constitutionally protected activity." On September 16, 2014, the Western District of Texas threw out MPHJ's suit, ruling that MPHJ had not exhausted its administrative remedies because the FTC's investigation was ongoing, and there was no "final" agency action to dispute.

On November 6, 2014, the FTC announced its settlement with MPHJ and published the proposed consent order. The proposed order would prevent MPHJ from making representations in its demand letters without "competent and reliable evidence" to back up its claims. Specifically, the FTC has identified the following demand letter claims to be "misleading" under the Federal Trade Commission Act (FTCA), unless the PAE has "competent and reliable evidence" to back up the claim at the time the letter is sent:

  1. A particular patent has been licensed to a substantial number of licensees;

  2. A particular patent has been licensed at particular prices;

  3. Any other statement concerning "the results of licensing, sales, settlement, or litigation of a particular patent;"

  4. Any statement about responses from other recipients of the demand letters;

  5. The PAE has filed a lawsuit against the recipient;

  6. The PAE will initiate a lawsuit if the recipient does not agree to a license, pay licensing fees, or otherwise respond; and

  7. The PAE will initiate a lawsuit within a specified period of time, or imminently, if the recipient does not comply

However, the FTC also specified that statements asserting that the recipient is infringing the patent or needs a license, or that the PAE reserves its rights under the patent, are not "misleading" without more. The proposed consent order is subject to public comment through December 8, 2014.

Under the consent order, MPHJ will have to make copies of any demand letters available to the FTC for the next five years. Any violation of the consent order subjects MPHJ to a civil penalty of up to $16,000 per violation, which means $16,000 for each deceptive letter sent. Nevertheless, MPHJ appears undeterred from its aggressive patent assertion policy, claiming that its letters have all along been "accurate, required by law and protected by the First Amendment" and therefore would not require any material revision in light of the consent order.

Although the FTC has not yet indicated whether more patent troll actions are forthcoming, the settlement suggests that the FTC may become more active in policing deceptive practices of the more egregious PAEs. These developments may also fuel activity under state consumer protection laws, often referred to as "little FTC Acts," designed to supplement the FTC's mission of protecting consumers from unfair or deceptive practices. These laws allow individual consumers to sue companies engaged in misleading and deceptive practices, rather than relying on the FTC to bring enforcement actions. If you have received a demand letter asserting that you may be infringing a patent or need a license, the FTC's proposed consent order may present new ways to fight back.  Possible courses of action now include: 1) sending a response requesting the "competent and reliable evidence" that the sender must have to support its claims or 2) notifying the FTC about the misleading demand letter claims.  For more information about this topic, please contact Venable.