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Cannabis Operators Should Develop Patent Strategies Now – New Cannabis Ventures

June 12, 2020

 

If You’re Selling Cannabis Products, You Better Have a Patent Strategy

Guest post by Jay Yonamine, Co-Founder at Gene Pool Technologies

Patent Strategies Are Mission Critical for Cannabis Operators

Patents are mission critical to virtually all industries, and especially so during their early stages of growth. From glass to golf balls to sweeteners to smartphones and everything in between, the development and enforcement of patented technology is a core element not only of business operations but also of industrial growth and maturity. Plus, patents are big business: corporations spend an estimated $40B a year on filing and maintaining their patent portfolios alone, with hundreds of billions more spent on R&D used to generate the innovations, and billions on patent litigation and licensing fees. For example, in 2019 alone, smartphone manufacturers paid an estimated $2.6B in patent royalties.¹

Although the cannabis industry has not yet spent similarly large dollars on patent royalties, it is inevitable that patents will also play a crucial role in the cannabis industry. Today we are at an inflection point in the industry driven by a rapid increase in patented innovation (cannabis-related patent applications have more than tripled since 2015, according to Law360), growing revenue, and a pervasive indifference to patent rights that all but ensures widespread infringement.

Despite the ramp up in patent filings, most operators are still woefully unprepared to face the potential onslaught of infringement claims and lack a robust risk-mitigation strategy. This is especially true of companies selling concentrates-based products—be it edibles, topicals, shatter, butter, or vape cartridges—since all of these products directly or indirectly utilize extraction equipment, which represents some of the most advanced and heavily patented technology in the industry. Companies that produce and sell concentrate-based products are almost certainly infringing someone’s patents and are at serious risk of being subject to patent litigation.²

Take a moment to let that sink in. A number of thoughts may have jumped into your head, including:

● You can’t get patents covering cannabis products, get lost.³
● My lead PhD scientist told me he invented all of the technology we use, get lost.⁴
● We buy our goods and materials from third parties so they’re liable, not me, get lost.⁵
● Maybe so, but who cares, no one is getting sued, get lost.
● I’ve been worried about this, what should I do?

If any of those reactions resonated with you, then you’re in the right place and should keep reading. In the rest of this article, we’re going to explain why those in the ‘get lost’ categories should migrate to the ‘what should I do?’ category, and why your biggest patent risk might not be what you think it is. We’ll also provide some answers to the ‘what should I do?’ question to help operators start protecting their innovations while also taking steps to meaningfully mitigate their current and future patent risk.

The Worst-Case Scenario is a Very Bad Scenario

Before we go any further, we need to address what can actually happen to companies that opt to not address their patent risk. What’s the worst that could happen? The most severe outcome, although rare in the United States, is that you receive an injunction, which prohibits you from making, using, or selling a product that was deemed to infringe another’s patent rights. The less severe, but far more likely ‘worst case scenario’ is that you’ll receive a complaint from a patent owner alleging infringement, you’ll tell them to ‘get lost’, they’ll file suit in court, where you’ll have to spend hundreds of thousands or millions of dollars defending your position in formal litigation. At that point, you may opt to settle, but the terms you will be offered will likely be far more expensive than those you would have received if you had negotiated terms before going to court (or, even more ideally, before the claim is even made). If you decide to litigate to a verdict rather than settling and the jury sides with the plaintiff, you’ll end up paying a portion of past and future revenue attributable to the infringing product, with this rate tripling if the jury believes that infringement was ‘willful’ (i.e. known by you, the defendant), and potentially even be forced to reimburse the plaintiff’s legal fees. For cannabis operators in a hyper-competitive market, potentially struggling with thin margins or cash flow challenges, losing a patent litigation could mean the end of the company.

The ‘Get Lost’ Attitude is Likely Going to Cost More

Given the history of the industry, the ‘get lost’ attitude is understandable, even if misguided. Much of the cannabis industry still operates with a ‘legal adjacent’ mindset, especially with respect to patents, and only a few years ago it would have been unthinkable for most operators to even consider paying a royalty for the right to use a patented technology.

There are at least three additional market conditions that also help explain this attitude. First, there were and might still be seemingly reputable law firms providing poor legal advice, like incorrectly advising clients that ‘you cannot patent cannabis’. Second, the cannabis industry has seen minimal patent enforcement across all segments. Third, many operators over the past few years have been in perpetual survival mode, so the last thing on their minds is patent risk. Given all of this, it’s understandable why almost no cannabis operators have meaningful patent strategies, but it is also dangerously shortsighted, and especially so for companies with concentrates-based products.

Concentrates-Based Products Carry Heightened Patent Risk

Why? Because critical aspects of the concentrates-based products supply chain have been and continue to be patented. Unlike selling raw flower, which requires less technology, concentrates-based products involve highly technical and fine-tuned equipment and processes that have been invented and patented in the past decade.⁶ You might not know that these patents exist, but they do. There are over 60 issued patents covering extraction technologies that have become widely adopted, including in-line dewaxing, low-temperature extraction, and solvent recovery techniques. Add in patents covering post-extraction treatments, formulations, and delivery mechanisms, and you’re looking at hundreds of more patents.

Additionally, the concentrates market is now the largest and fastest growing sub-segment of the broader cannabis industry, with (legal) 2019 revenues estimated at $6B a year and growing at 30% annually, according to BDSA, so ‘get lost’ is no longer a viable business plan. If a patent owner is able to make a credible case of potential infringement, you’re either negotiating a deal or you’ll be forced into litigation, which can lead to one or more of the difficult outcomes as previously discussed. Thus far, few cannabis companies have had to make this type of decision. But inevitably, you will. There are people — be they independent inventors tinkering in their garage or highly compensated scientists at billion-dollar companies — who have dedicated their lives to developing and patenting the innovative technology on which the industry is built, and they will eventually be recognized and compensated. Additionally, the industry, as it grows and matures, will increasingly depend on incentivizing investment in R&D and innovation, which also requires that the industry follows general business best practices, such as paying for the rights to practice patented technologies.

With Patents, it Pays to be Proactive

By this point, if you were initially in the ‘get lost’ category, hopefully you’ve come around to the ‘so what should I do?’ category, and if you were in the ‘what should I do?’ category, you’ve realized that a patent strategy should move up higher on your To-Do list. So what are the right steps to take?

Bring in the Experts

The first step to begin developing a robust patent strategy is to bring in an expert. Large cannabis operators may opt to hire a full-time patent counsel (or may already have a team), but for most operators, it will be far more cost efficient to find and retain patent counsel at a law firm. When doing so, make sure that your counsel has relevant patent domain and industry experience. In terms of patent experience, some counsel are highly specialized in patent prosecution (i.e., helping inventors obtain patent rights for their ideas), others focus on litigation, and others still on licensing and patent sales. Ideally, you’ll find a firm with experience in all three areas. With canna-patents, it’s also optimal to find a firm with both the relevant technical background (e.g., chemistry, pharma) and cannabis experience, which is becoming increasingly possible as a number of established firms are launching cannabis-specific patent services. A skilled firm will be able to help assess your current risk via a detailed review of your existing products, contract agreements with equipment manufacturers and other product suppliers, and the landscape of relevant existing patents. After this initial review, they will be in a position to help you devise a comprehensive go-forward patent strategy.

Generally, all patent strategies will be based on one or more of the six risk-mitigation methods detailed below.

The Six Main Ways to Mitigate Patent Risk

Pay for a Standard License:

This is the most common, straightforward, and generally cost-effective approach to mitigating patent risk — you simply negotiate a price to pay for the right to use someone else’s patented technology. Patent licenses take many forms, but the most vanilla versions include either a lump sum or recurring rate to use technology claimed in a list of enumerated patents for a specific product. Virtually every company in the S&P 500 derisks their products via patent licenses. In most instances, there are first-mover advantages to receiving lower royalty rates (i.e. the percent of revenue that you pay), so it is often in operators’ best interest to be proactive.

Alter Products Based on Freedom to Operate Analysis:

Freedom to Operate is a rigorous process by which patent counsel and product engineers collaborate before the launch of new products and features to determine the extent to which they may be infringing third-party patents. When potential infringement is found, the company can decide to drop the feature before going to market, design-around the existing patents to replicated the feature as best they can using different technologies, negotiate a licensing deal with owners of potentially infringed patents to pay for the right to use the technology, or take a calculated risk to go to market with the infringing product or feature even though this will likely lead to litigation.

Deter Litigation via Portfolio Growth:

A common risk-mitigation strategy in more mature industries is to deter patent risk by building a patent portfolio, either organically by filing patents on your own innovations or by acquiring third-party patents. Owning a strong portfolio may enable you to deter other companies from asserting patents against you because you would be able to counter-assert with your own assets. In some industries, this dynamic of mutually assured destruction has led to a peaceful detente between companies. Additionally, owning a portfolio can enable you to pursue cross-licensing agreements, which can be a cost effective tool to mitigate risk.

Acquire Infringed Patents:

If you identify patents that your company’s products are infringing (either via a proactive search or via a formal complaint from the patent owners), an alternative risk-mitigation strategy is to acquire the patents. By acquiring the patents, you have assumed the right to practice their claimed technology (and enforce it against others), thereby completely eliminating the risk posed by those patents. Often, however, this is the most expensive option and generally only efficient if you plan to use these patents to gain leverage against competitors via enforcement or the deterrence mechanism explained above.

Roll the Dice in Litigation:

While the vast majority of patent disputes are settled out of court, litigation occurs when parties cannot come to terms. Patent litigation is generally the most time intensive and costly risk-mitigation option and is also the least predictable, since verdicts can be awarded by juries composed of non-patent professionals.

Attempt to Invalidate:

Inter Partes Review (IPR) was introduced in 2012 as part of the America Invents Act, which allows someone to challenge the validity of one or more claims in a patent even after the patent has been granted by the USPTO. Whereas traditional litigation generally arises over disputes about the degree of infringement of a patent, IPR’s address whether or not claims in the patent should not have been allowed in the first place. Challenging the validity of a patent is a common risk-mitigation strategy, although it is primarily used in the software industry, where patent examination is more difficult because the subject matter tends to be more abstract compared to other industries.

Conclusion

The cannabis industry is one of the fastest growing and dynamic industries in the world. Although cannabis has been cultivated and consumed for centuries, the last decade has seen exponential growth in investment and innovation across genetics, formulations, pharmaceutical application, and specialized machinery. Many of these innovations, which form the foundation of the industry today and will fuel continued growth, were patented by their inventors. Patents in the cannabis industry present both tremendous opportunity and risk for operators. Opportunity in that companies that are differentiating their processes and products via true innovation have a mechanism to protect their inventions, and risk in that almost every operator today is likely infringing patents owned by someone else. Right now, few cannabis companies have faced meaningful disruption from patents, but this is inevitably going to change. A small number of mostly large and sophisticated operators already have robust patent strategies. For the rest of the industry, the window is closing and the time to act is now.

¹Calculated by multiplying the cumulative royalty rate from the Hoover Institute by the total sales estimated by Statista.
²Growing and selling flower carries far fewer patent risks.
³You can.
⁴He hasn’t. Unless his name is Thomas Edison, and even then he probably hasn’t.
⁵Even if your suppliers and equipment manufacturers have granted you patent indemnification (which is extremely rare thus far in the cannabis industry), you will still likely be dragged into a litigation even if the primary defendant is the supplier/manufacturer. Patents are infringed via ‘make, use, or sell’, at least one of which you are doing.
Considerable R&D and patent activity are also occurring at the genetic plant level, which could raise patent risk for growers as well as concentrates-based product producers.


About the author:

Jay is a co-founder of Gene Pool Technologies, a leading cannabis technology and intellectual property company. Jay also leads data science and global operations for Google’s global patents org. He’s a well-known figure in the corporate patents world, regularly speaking globally and was recognized in 2019 as a Top 300 global patent strategist.

The author thanks Patrick Rea of CanopyBoulder for his assistance with this article.