George Mason University Antonin Scalia Law School

The History of Patent Licensing and Secondary Markets in Patents: An Antidote to False Rhetoric

The patent licensing business model is a flashpoint of controversy in the patent policy debates. Individuals and firms that specialize in licensing patented innovation – and companies that purchase patents in order to license them – have come under attack by the President, members of Congress, companies, lobbying groups, and others. On December 6, 2013, the House of Representatives passed a bill (HR 3309) that specifically targets the licensing and litigation of patents. Thus, the patent licensing business model has taken center stage in the public policy debates in a way not seen since the late nineteenth century — when the popular rhetorical epithet for these companies was “patent shark.”

Today, patent licensing entities are referred to as “non-practicing entities” (NPE), “patent assertion entities” (PAE), or the more fashionable and inflammatory term “patent troll.” As I explained in my recent Senate testimony, these monikers, especially “patent troll,” are more rhetorical epithets than settled, objective, descriptive terms, as evidenced by the fact that they are applied arbitrarily against all types of patent owners. But the similarities between the nineteenth-century rhetoric and today’s rhetoric is striking, and thus this essay provides a brief overview of the history of patent licensing and of the buying and selling of patents (what patent lawyers and economists call “secondary markets”).

An historical review of patent licensing and secondary markets, even if brief and necessarily incomplete, is important because history is used to frame the patent policy debates today. Unfortunately, in addition to mistaken empirical claims based on flawed statistical studies, the policy debates are riddled with mistaken claims about past legal and commercial norms concerning patented innovation. For instance, law journal articles often state that the “patent marketplace is a relatively new secondary market.” Many commentators simply assume that patent licensing is a new phenomenon, and thus they assert that the patent system should now adopt a manufacturing requirement for patent owners in order to address the allegedly “new” problems caused by the supposedly “new” patent licensing business model. Through rote repetition in scholarship, blogs, op-eds and newspaper articles, such claims have solidified into conventional wisdom among policy and legal elites.

This conventional wisdom (like much conventional wisdom) is profoundly mistaken. As award-winning economist Zorina Khan has explained in her thoroughgoing research into the history of the American patent system, licensing has long been an essential feature of the uniquely American patent system, which secured property rights in innovation to both inventors and to the marketplace actors who commercialized the innovation.  Professor Khan and other economists have recently expanded upon and extended their historical research to more directly address today’s hot-button policy debate concerning patent licensing and secondary markets. Legal historians, such as Christopher Beachamp, have also begun delving into the historical record and have found a wellspring of materials on secondary market and patent licensing activities in the nineteenth century.

This historical research should be read by all lawyers, scholars, or commentators who are interested in or concerned about the patent licensing business model and related issues, such as patent litigation.  In this short essay, I can only briefly summarize some of this research and expand upon it with contributions from my own research into the primary sources in the nineteenth-century American patent system. In fact, my own historical scholarship has reached similar conclusions, as I found that early American legislators and judges regarded patents as property rights – defined specifically as civil rights securing fundamental property rights – and that this had profound real-world implications in the unfettered sale and licensing of patents in the nineteenth-century marketplace.

I.   The Patent Licensing Business Model in the Nineteenth Century

The patent licensing business model is not a new phenomenon in the commercialization of patented innovation in the marketplace. Of course, a complete survey of all such individuals and firms who used the patent licensing business model to commercialize patented innovation is beyond the scope of this short essay, and so I will focus here on just a few prominent examples of the patent licensing business model in the nineteenth century. This part thus focuses on Thomas Edison, Charles Goodyear, and Elias Howe, Jr. The latter inventors are significant, because they prove that long before Edison began his massive inventive labors in the late nineteenth century, prominent inventors and patent owners utilized the patent licensing business model in the early nineteenth century (what historians call the Antebellum Era), revealing that this commercial practice has very old historical antecedents.

1.   Thomas Alva Edison

Thomas_EdisonMany people do not realize that Thomas Edison was an exemplar of the patent licensing business model, and he certainly meets the definition of an “NPE” employed in the patent policy debates today. Edison sold and licensed his patents, especially in his early invention-intensive career. As discussed in one recent article, he conveyed at least 20 of his early patented inventions to third parties in order to fund his full-time research and development efforts. He also assigned outright some of his later patents; as reported by another scholar, Edison sold his patents in his innovative incandescent light bulbs to the General Electric Company.

But Edison is admittedly a mixed example because he also directly engaged in the manufacture and sale of some of his patented innovations, such as the electric light bulb and the phonograph. These business ventures, however, were lackluster at best and disastrous at worst. In the compelling account of Edison’s career, The Wizard of Menlo Park: How Thomas Alva Edison Invented the Modern World, Randall Stross recounts how the products that ultimately dominated the marketplace from Edison’s initially path-breaking inventions were oftentimes those of his competitors, such as the Victrola record player. As his close friend, Henry Ford, famously quipped, Edison was “the world’s greatest inventor and the world’s worst businessman.” (Ford knew of which he spoke, because, as Stross recounts, Ford provided Edison a total of $1.2 million in business loans, some of which he was forced to forgive.)

Thus, while Edison easily meets the definition of an “NPE” given his embrace of the patent licensing business model early in his career, he also serves as an important lesson given his many failures in the business world later in his career. At the end of the day, Edison should have stuck with the patent licensing business model that brought him his early fame and fortune as a young innovator at Menlo Park.

2.   Charles Goodyear (Patent No. 3,633)

CharlesGoodyearCharles Goodyear invented the process for vulcanized rubber in 1839 and received a patent for it on June 15, 1844 (Patent No. 3,633), but he never manufactured or sold rubber products. Instead, Goodyear only sold his rights in his patented innovation to other individuals and firms—transferring in the marketplace the rights to license, manufacture, sell, or use the process of vulcanizing rubber.  These individuals and firms produced the ubiquitous rubber products that formed a critical part of the Industrial Revolution, and many of Goodyear’s licensees also engaged in extensive litigation against end-users, such as dentists.

As reported by biographers, Goodyear was crazy about rubber and about inventing and finding new uses for it. He even wrote a two-volume treatise (Gum Elastic and Its Varieties) on the history, invention, and uses of vulcanized rubber. True to form, Goodyear even had several copies of this treatise printed with “hard rubber bindings and covers,” and, as one historian of technology recounts, “Page after page of Gum-Elastic is devoted to [listing] different kids of boats, life preservers, buoyant travel bags and even frogman suits, but also … fire hose, escape rope and medical instruments” that could be made with rubber. As the archetype of the obsessive inventor, Goodyear was not interested at all in manufacturing or retail sales of his patented innovation.

It is also significant that many of the individuals and firms who purchased patent rights from Goodyear brought many, many patent infringement cases in the nineteenth century. In fact, the Goodyear Dental Vulcanite Company was a patent licensing company that sued hundreds, if not thousands, of dentists for patent infringement. This proves that the claims today that “end-user lawsuits” are an entirely new phenomenon are just as wrong as the mistaken claims about the allegedly new phenomena of patent licensing and the secondary markets.

Of course, many people do not know about Goodyear’s early claim to fame as an “NPE” because they mistakenly associate the eponymously named Goodyear Tire & Rubber Company with the inventor. But this company is merely named after the famous inventor, as it was formed in 1898, almost four decades after Goodyear’s death in 1860. (It was even involved in a trademark lawsuit with Goodyear’s descendants over the use of the name.)

3.   Elias Howe, Jr. (Patent No. 4,750)

Elias Howe, Jr.Elias Howe, Jr., invented the lockstitch in 1843 and he received a patent for it on September 10, 1846 (Patent No. 4,750), and he also licensed this patented innovation for most of his patent term. Similar to many patent licensing companies today, Howe often entered into royalty agreements after suing commercial firms and individuals upon discovering that they were infringing his patent rights. One historian referred to Howe’s patent litigation practice of “suing the infringers of his patent for royalties” as his “main occupation” for “several years.” In fact, Howe’s assertion of his patents against infringers who refused his licensing offers precipitated the very first “patent war” in the American patent system — the Sewing Machine War of the 1850s (as it was called at the time in newspapers and among the litigants).

Howe’s litigation practices were both innovative and controversial. Interestingly, he employed patent litigation practices that are routinely called novel when they occur today. For instance, Howe was destitute when his licensing demands were refused in the early 1850s, and thus he found a businessperson to invest in his patent infringement lawsuits, receiving funding from and selling a one-half interest in his patent to George W. Bliss. (This is called “third-party financing” today.) Ultimately, after being a principal legal pugilist in the Sewing Machine War, Howe joined the Sewing Machine Combination of 1856, the very first patent pool in American history, through which he made almost the entirety of his multi-million-dollar fortune on the basis of his royalties. Yet, his licensing and litigation practices remained the source of much public scorn; one 1867 magazine article acerbically stated that “the secret of Mr. Howe’s success” was that “he litigated himself into fortune and fame.”

In sum, Howe, Goodyear, Edison and many, many others confirm that the patent licensing business model has not only existed since the early nineteenth century, it also has served a significant function in the commercialization of patented innovation in the United States. Other famous early nineteenth century inventors also extensively assigned and licensed rights in their inventions in addition to engaging in manufacturing and other commercial activities themselves. The list includes William Woodworth (planing machine), Thomas Blanchard (lathe), and Obed Hussey and Cyrus McCormick (mechanical reaper), as well as many others. Such commercial practices continued into the twentieth century and up through today, with innovative firms like Bell Labs, IBM, Apple, and Nokia, among others, using this long-established tradition of commercializing patented innovation through the patent licensing business model.

II.   Secondary Markets in Patents in the Nineteenth Century

Despite the fact that Goodyear, Howe, and others licensed their patents and patent rights, the conventional wisdom today is that historically there have been no markets in patents by which non-inventors profited from the secondary sale, licensing, or other uses of patented innovation. In effect, the claim is that today’s “patent marketplace is a relatively new secondary market.” This conventional wisdom is just as mistaken as the conventional wisdom regarding the alleged novelty of the patent licensing business model itself.

1.   Secondary Markets in the Antebellum Era (pre-Civil War)

In the Sewing Machine War in the 1850s, the various patents obtained by different inventors on different components of the sewing machine were purchased or exchanged between a variety of individuals and firms. In fact, one of the most significant inventive contributions to the development of the sewing machine was made by John Bachelder (Patent No. 6439, issued May 8, 1849), but Bachelder neither manufactured sewing machines nor licensed his patent. He sold his patent to Isaac Singer, who ultimately assigned it to the pool of patents owned and licensed by the Sewing Machine Combination, the patent pool formed in 1856 by Singer and other patent owners to resolve the hard-fought Sewing Machine War.

Even before the outbreak of the Sewing Machine War in the early 1850s, there was patent litigation brought by secondary owners of patents. As I report in my article, for instance, in 1849, one sewing machine inventor

had the unfortunate distinction of being the first sewing machine patentee threatened with litigation for infringing another sewing machine patent. After [Allen B.] Wilson invented a double-pointed shuttle in 1848, A.P. Kline and Edward Lee, the owners of the [John] Bradshaw patent, threatened Wilson with a lawsuit for infringing their patent. Lacking the funds to defend himself, Wilson sold his patent rights to this particular invention to Kline and Lee to settle the dispute.

In sum, Bradshaw had obtained a patent on sewing machine technology in 1848 and then sold it to Kline and Lee, who then sued Wilson for patent infringement. In exchange for settling their lawsuit against him, Wilson transferred his 1848 patent to Kline and Lee. (Wilson was undaunted by this experience, as he proceeded to obtain three more patents on sewing machines). Regardless of what one thinks of the propriety of Kline and Lee’s lawsuit against Wilson, it is clear that in the 1840s they were engaged in a secondary market in acquiring patents and asserting them against infringers.

Such sales and transfers of patents and patent rights were not limited to sewing machines, and in fact were very common for all patented innovation in the nineteenth century. In the classified ads section in an 1869 issue of Scientific American, among ads touting the value to purchasers of “Woodbury’s Patent Planing and Matching and Moulding Machines” and ads declaring “AGENTS WANTED – To sell H.V. Van Etten’s Patent Device for Catching and Holding Domestic Animals,” one can find ads offering for sale patents and rights in patents: A patent on a farm gate to sell or exchange for a No. 1 S-horse power portable steam engine. Address C. H. Embree, West Dresden, Yates Co., N.Y.; Bent, Goodnow & Co., Boston, Mass., Agents for the sale of Patents. For Sale - a variety of very valuable "Rights." Send stamp for The Patent Star, Containing description of each.; Patent Rights Sold on Commission, and Valuable Inventions introduced by the most experienced Patent Salesmen in the Union. Can refer to over one hundred inventors for who we have acted. E. E. Roberts & CO., Consulting Engineers, 15 Wall St., New York.

Image from Scientific American (Aug. 28, 1869), p. 143.

Again, this was not unusual. The classified ads sections in nineteenth-century issues of Scientific American reflect incontrovertible evidence of both secondary markets in patents and the patent licensing business model. One page of classified ads in an 1854 issue of Scientific American, for instance, has the following ads for the sale of patents and patent rights: For Sale, Low. - The Patent of a Self-Unloading and Adjusting Hay Elevator. Patented May 30th, 1854. Address, Horsham, Pa., 43 7 T. T. Jarrett, Patentee. Patent Right for Sale - State Rights in a new and improved machine, designed for ship and boat spikes, patented July, 4th, 1854. This machine is entirely new, and comprises a new and patented method of pointing, whereby a great amount of labor in repairing is saved. Application should be made to F. Humphrey, Boonton, N.J. 47 2. Patent Right for Sale - We are ready to dispose of the Patent Right, (or any part of it) of the best Stone Drilling Machine now in use, or we are prepared to furnish working machines at very reasonable prices, these machines will drill from 1 to 7 inches in diameter, and 100 feet deep, and can be worked by Hand, Jorse, or Steam Power, one machine performing the work of twenty-five men. For further particulars and circulars with cuts address Jas. T. Whittemore, Agent American Manufacturing Co., 29 State Street, Boston. 40 tf.

Image from Scientific American (Aug. 12, 1854), p. 383.

2.   Secondary Markets in the Late Nineteenth Century

The secondary market in patents continued throughout the nineteenth century, as confirmed in recently published research by economists Naomi R. Lamoreaux, Kenneth Sokoloff, and Dhanoos Sutthiphisal. Their research reveals the fundamental, significant role performed by patent attorneys as market intermediaries in the late nineteenth century, effectively serving as predecessors of today’s patent aggregators. This included one businessperson who “invested in patents for hat-frame formers, rails for high-speed railroads, electric railroad systems, and pliers.” Another’s “investments spanned the technological gamut from envelopes to drills to arc lamps to sewing machines to railroad signaling systems.” As Lamoreaux, Sokoloff, and Sutthiphisal indicate, the wide-ranging innovation invested in by these individuals “suggests they were not primarily manufacturers seeking to improve the efficiency of their production processes or expand their product lines.”

Admittedly, these businesspersons were closer to what we would define today as angel investors or venture capitalists, but this is more likely the result of legal, market, and technological factors that are exogenous to the patent system. For instance, the twentieth century witnessed incredible innovation in the development of advanced forms of corporate structure, as well as equally innovative development of complex legal and financial mechanisms, that allow for commercialization of patented innovation in ways that would have been outright impossible (or grossly inefficient) in the nineteenth century. Moreover, the technological advances wrought by the digital revolution — computers, the Internet, email, smartphones, wireless telecommunications, and many others — have reduced substantially the information costs and transaction costs in the commercialization of patented innovation.

Such factors are significant because they directly affect the commercialization of patented innovation, and thus they cannot be ignored in assessing historical practices in the innovation industries. The creation of the Sewing Machine Combination of 1856, the very first patent pool, as well as the Singer Sewing Machine Company’s radical commercial innovation in mass marketing and in developing the first rent-to-own and trade-in programs, is significant evidence of the dynamic and mutually reinforcing relationship between technological, legal and commercial innovation. In brief, innovation breeds innovation, and we must therefore be careful to avoid anachronistic judgments about the nineteenth-century absence of today’s aggregation of large-scale patent portfolios by corporations engaged in manufacturing, licensing, or both.

Within the constraints of primitive nineteenth-century corporate law and financial mechanisms one easily finds an abundance of “patent agents,” commercial investors, patent licensing practices, and secondary markets in patents.  This fact is significant evidence by itself that today’s secondary markets and patent licensing business models have clear historical antecedents. Notwithstanding any legal or corporate differences, it is simply false to assert that secondary markets in patents and patent licensing are new phenomena today. Such assertions, reflected in today’s conventional wisdom, are myth, not reality.

III.   Conclusion

Of course, the twenty-first-century innovation economy is incredibly different from that of the nineteenth-century innovation economy. The exogenous market and technological variables at work in this economy are different as well. But the conventional wisdom today that the patent licensing business model and secondary markets in patents are new and unprecedented is simply false.  It is equally wrong to infer a negative policy judgment from this mistaken historical claim. Whether there is benefit or harm from such commercial innovation is an important empirical and policy question, but such benefits or harms should no more be based on incorrect claims about historical practices than they should be based on studies that are, in the words of the GAO Report on Patent Litigation, “nonrandom” and “nongeneralizable.”

In fact, the long history of the widespread adoption and use of the patent licensing business model, as well as the secondary markets that make such patent licensing business models possible, should be unsurprising. These commercial activities reflect the basic economic principle of the division of labor that Adam Smith famously recognized as essential to a successful free market and flourishing economy—in this context, it is the division of labor between inventors and businesspersons. Commentators (and Congress) should tread very carefully in seeking to abolish this long-established feature of the American patent system.