A Theory of Pre-litigation Settlement and Patent Assertion Entities

Abstract: An informed (potential) plaintiff can demand a payment from an uninformed (potential) defendant with the threat of a law suit that may not be credible. The communication takes place before the law suit is filed and is costless to both sides. A unique equilibrium that satisfies the intuitive criterion exists and exhibits partial pooling—cases below a cutoff of legal damage reach pre-litigation settlement, while those above are filed for suit. This equilibrium offers an explanation for the distinctive behaviors of litigation PAEs who aggressively file law suits for settlements and portfolio PAEs who obtain licensing revenues through pre-litigation settlements. Among other results, we shows that, in the US legal system, increasing a plaintiff’s legal costs or adopting the fee-shifting rule reduces the number of filed law suits while risking driving more cases toward pre-litigation settlements. Surprisingly, reducing a defendant’s legal costs or increasing trial costs has the opposite effects.