Different Rules of Legal-Cost Allocation and Patent Hold-Up

Abstract

We study how different rules for allocating litigation costs impact on royalty negotiation in an environment such as the information technology sector where patent hold-up is possible. We first consider the American system, where each party bears its own costs, and the British system, where the loser incurs all costs. We show that in the assumed context it is not possible to decide which of these two “normal” systems is preferable. In particular, under flat lawyer fees the British system proves to be more effective in counteracting hold-up if the patent at issue is relatively weak, while for relatively strong patent the opposite is true. Under contingency-fee arrangements, where lawyer fees are determined by the success of the claim, the American system is preferable whatever the patent strength. These conflicting results have lead us to consider a less usual system for allocating litigation costs, namely the system favoring the defendant, where the defendant pays its own costs if it loses and nothing otherwise. This system proves to be an interesting alternative whatever the patent strength and the lawyer-fee arrangement.

Keywords: licensing, permanent injunctions, patent hold-up, litigation costs

JEL Classification: K41, O34