Different Rules of Legal-cost Allocation and Patent Hold-up

We study how different rules for allocating litigation costs impact on royalty negotiation when a non-practicing patent holder asserts its patent against a product developer. A theoretical framework is proposed which distinguishes between three legal cost allocation systems: the American system, where each party bears its own costs, the British system, where the loser incurs all costs, and the system favoring the defendant, where the defendant pays its own costs if it loses and nothing otherwise. The model considers both flat lawyer fees and contingency fees. We first determine conditions under which, in the assumed contexts, the American system is preferable to the British one. Successively, we show that the less usual system favoring the defendant proves to be an interesting alternative. In this way, in addition to extend the standard model of patent hold-up, we furnish an analytical treatment of recent legislative proposals, such as the Saving High-Tech Innovators from Egregious Legal Disputes (SHIELD) Act of 2013.