**CECIL D. QUILLEN, JR.**

**1776 EYE STREET, NW**

**SUITE 600**

**WASHINGTON, DC 20006**

September 17, 1999

NATIONAL SCIENCE AND TECHNOLOGY COUNCIL

Committee on Technology

Old Executive Office Building, Room 423

Washington, DC 20502

Subject: PRIORITIES FOR FEDERAL INNOVATION REFORM

Ladies and Gentlemen:

I am submitting this in response to your request for Issues Papers
concerning Federal Policy in Support of a National Innovation System.
This paper is not submitted on behalf of any organization or entity.
Rather it is submitted based on my own experience with innovation
issues. I am presently affiliated with PHB Hagler Bailly, Inc., an
economic and management consulting firm. Prior to my affiliation with
PHB Hagler Bailly, I was Senior Vice President & General Counsel of
Eastman Kodak Company where I spent 30 years in various legal and
business assignments, most of which involved innovation and intellectual
property issues. The views expressed herein are my own and should not be
attributed to PHB Hagler Bailly or Eastman Kodak. I may be reached at
the address set forth above. My telephone number in Washington is
202-725-7290, my fax number is 202-396-3858, and my Email address is
cquillen@haglerbailly.com.

The U.S. patent system is a significant part of the \"National
Innovation System\" and is supposed to foster innovation in the United
States. However, certain features of the U.S. patent system, including
certain changes brought about by the Court of Appeals for the Federal
Circuit, have resulted in lowered standards for patentability, increased
uncertainty as to the outcome of potential patent litigation, and
damages awards which exceed the amount a patentee would have obtained
had there been no infringement. These features and changes combine to
unnecessarily increase the cost (and risk) of innovation investments in
the United States. The consequence of the increased cost and risk is
that we get less innovation than we otherwise would, and it costs us
(consumers) more. Innovation in the United States would be fostered if
our patent system was simplified and reformed so as to eliminate the
unnecessary cost and uncertainty it imposes on the innovation process.
The U.S. patent system is exclusively a Federal activity and, as
previously mentioned, is a significant part of our \"National Innovation
System.\" It is therefore appropriate that the Committee should review
the patent system with an eye to proposing simplifications and reforms
intended to foster innovation in the United States.

The lowered standards for patentability have been the subject of comment
by a number of observers, some of whom are identified in a paper I read
at an American Bar Association Continuing Legal Education Institute in
1992. The consequence of the lowered standards for patentability is that
innovators who wish to avoid the patents of others must now expend more
time, effort, and money in evaluating patents held by others, with the
result that the innovator\'s costs are higher than they otherwise would
be. And those who wish to try to preserve the right to commercialize
their own work and minimize or avoid \"patent harm\" by seeking patents
on their own work must file more patent applications (and incur higher
expenses) than they otherwise would, or devise other methods for dealing
with the resulting proliferation of patents.

One manifestation of this patent proliferation was revealed in the
recent Federal Trade Commission action against Intel in which the FTC
challenged certain business practices Intel had adopted to deal with the
\"patent minefield\" it faced as a consequence of the increased number
of patents resulting from the lowered standards. Another manifestation
of patent proliferation is the recent court decision extending the
availability of patent coverage to financial business methods involving
the use of computers. The financial services industry certainly has a
long history of innovation without participating in the patent system
and without having to bear the costs of doing so. Now that industry has
had the patent system imposed upon it, and its members will have no
choice but to participate in the patent system and bear the costs of
that participation to the detriment of its customers, who will
ultimately bear those costs.

The increased uncertainty (or lack of predictability) as to the outcome
of potential patent litigation was pointed out by Judge Michel of the
United States Court of Appeals for the Federal Circuit in a law review
article published in the Summer, 1994 Edition of The American University
Law Review. This is a particular failing of the U.S. patent system as
any legal regime (including the U.S. patent system) should inform those
affected by it of their rights and duties in advance so they can act
accordingly without the need for engaging in litigation. The uncertainty
(or lack of predictability) inherent in the U.S. patent system was
dramatically illustrated in Polaroid\'s litigation against Kodak with
which I am familiar. Kodak was adjudged to have employed a patent
clearance process that was \"a model for what the law requires.\" Yet
Kodak\'s \"model process\" was wrong as to 7 of the 12 patents involved
in that litigation. Kodak\'s \"batting average\" was, in effect, 0.417.
Surely no potential innovator is going to go forward with innovation
investments in the face of adversely held patents when 0.417 is the best
a \"model process\" can do.

The cost of patent uncertainty, which manifests itself as increased cost
of capital for innovation investments, was also illustrated in Polaroid
v. Kodak. There was uncertainty as to the damages that would be awarded
to Polaroid. That uncertainty was eliminated by the announcement of a
\$905 million judgment [against]{.underline} Kodak. But elimination of
the uncertainty resulted in a \$795 million [increase]{.underline} in
the equity market value of Kodak (and a corresponding decrease in the
cost of Kodak\'s equity capital). Obviously Federal policies that
minimize uncertainty and improve the predictability of the outcome of
potential patent litigation would substantially reduce the cost of
capital for innovation investments and thus diminish an impediment to
innovation.

The consequences of the lowered standards and increased uncertainty (or
unpredictability) are apparent from an article by Jon Merz and Nicholas
Pace of the RAND Corporation, published in the August 1994 edition of
the Journal of the Patent & Trademark Office Society, who noted
increased patent application filings and increased patent litigation
following formation of the Court of Appeals for the Federal Circuit. The
lowered standards make it necessary for those who wish to preserve the
opportunity to use their own work and protect themselves from \"patent
harm\" to file more patent applications than they otherwise would, which
may very well explain the increased patent filings noted by Messrs. Merz
and Pace. The increased filings necessarily result in increased costs.
Similarly the increased uncertainty (lack of predictability) may explain
the litigation increase noted by Messrs. Merz and Pace. Obviously there
will be more lawsuits if the results cannot be predicted in advance.
Neither the lowered standards nor the increased uncertainty are
favorable for innovation. Both increase costs for innovation
investments, and thus diminish incentives for innovation, with the
result that we get less innovation, and it costs us more.

Finally, the possibility of excessive damages, far greater than any
benefit obtained by the infringer or harm done to the patentee, are a
further deterrent to innovation. Potential innovators simply will not
make innovation investments where our patent system makes it uncertain
whether they can recover their investments and, in fact, exposes them to
the possibility of crippling damages, far in excess of any benefit they
might realize or harm they might do. And patentees, who have more to
gain through litigation than exploitation of their inventions, have
every incentive to prolong litigation.

Thus I would urge the Council to take up as an issue the extent to which
our patent system, particularly as it has been changed in recent years,
functions as an impediment to innovation, and the related question of
what simplifications and reforms should be implemented so that our
patent system will foster rather than impede innovation. In this regard,
in addition to the ABA CLE paper previously mentioned, I have published
a proposal for simplification and reform of the U. S. patent system, and
testified at the Patent & Trademark Office Hearing on Nonobviousness.
Please let me know if these materials, or any of the other materials
referred to herein, might be useful to the Committee and I will be happy
to provide copies.

Very truly yours,

Cecil D. Quillen, Jr.