Yahoo's Patent Litigation Plan Backfires

In a desperate attempt to increase revenue, Yahoo first threatened and then pursued a patent infringement lawsuit against longtime business partner Facebook . Yahoo probably thought the timing for a shakedown was ideal and that Facebook would quickly capitulate into a settlement. After all, with plans to go public as early as May 17, Facebook would likely feel tremendous pressure to buy its way out of any dispute that could lead investors to question the legal foundations of its business.

Yahoo had, in fact, succeeded with the same strategy in the past. When Yahoo bought Overture, it acquired an existing patent infringement suit against Google . That suit settled less than two weeks before Google's IPO with Yahoo receiving close to three million pre-IPO shares of Google stock. While Yahoo was hoping for a similar concession from Facebook, it was not to be.

In response to Yahoo’s threats and suit, Facebook sprang into action. Having owned just 56 U.S. patents at the end of 2011, Facebook’s first step was to acquire 750 patents from IBM and a number more from Philips , an NYU professor and other sources. It then carefully selected 10 of its patents and on April 3 filed an answer with the court, denying Yahoo’s claims and counterclaiming that Yahoo was infringing Facebook’s patents. Facebook’s denial was based on a variety of legal grounds including claims of non-infringement, invalidity or unenforceability of Yahoo’s patents, waiver, and express and/or implied license by Yahoo. The implied license defense is presumably based on Facebook’s deep integration into Yahoo’s services and the parties’ other ongoing business dealings.

Every aspect of the patents selected by Facebook for its counterclaim seems to be laden with meaning. Facebook only selected 10 of its patents, the same number claimed by Yahoo, probably to signal that, unlike Yahoo, it is simply defending itself rather than acting as a patent predator. Facebook employees invented two. Facebook CEO Mark Zuckerberg invented one, and a former Yahoo employee invented another. Furthermore, nearly every patent selected by Facebook trumps a corresponding Yahoo patent in the dispute on the basis of both specificity and strength (see Techcrunch).

Facebook’s refusal to roll over and play dead for Yahoo and its willingness to enter into a potentially protracted legal dispute reflects only part of a larger backfire of Yahoo’s plans. Yahoo has received widespread criticism from both technology and venture capital industry executives, as well as the general public, for failing to innovate and keep up with its younger Internet peers and, instead, recklessly choosing to act like a patent troll aggressor against important business partners. In the face of dwindling ad sales, decreasing revenues, layoffs, and internal management turmoil, senior Yahoo employees have been rushing for the exits. Yahoo’s new focus on litigation over innovation has further rankled its staff and is likely to accelerate the pace of their departures. A former Yahoo employee publicly criticized Yahoo for “weaponizing” the software he developed for the firm. All the bad publicity will certainly not enhance Yahoo’s recruitment efforts. And Yahoo is exposed to the risk that, once subjected to scrutiny, its patents may be declared invalid or unenforceable.

According to Facebook’s amended registration statement, it spent $83 million acquiring patents in the first quarter of 2012, and just agreed to pay $550 million to purchase approximately 650 patents that Microsoft is acquiring from AOL, as well as a license to hundreds of other AOL patents to be retained by Microsoft. That level of commitment to acquiring patent rights signals a new warning to Yahoo and other potential plaintiffs that Facebook is ready, willing and able to defend itself against patent claims. In reaction, Yahoo filed five responses to Facebook's counterclaims including a claim that Facebook lacks a good faith basis for its counterclaims and the addition of two more patents to Yahoo's  infringement claims against Facebook.  And on April 23, Yahoo wrote a letter to Facebook concerning the potential infringement of 16 additional patents.

At this point, the parties may proceed with a long drawn out legal battle even though it would require a high cost of time and resources and expose both companies to the risk of one or more adverse rulings that could have a material adverse impact on their respective businesses. A more likely scenario is that the parties slug it out for a period of time in federal court and then craft a settlement involving cross-licenses and, as a sweetener, perhaps a payment to Yahoo as well. One especially intriguing outcome, however, would be an “investment” on Facebook’s part in a broad cross-license settlement with Yahoo that includes Yahoo’s search-related patents, as the addition of search functionality to Facebook’s services would be a real ecosystem enveloping game changer.