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In this paper, we formally demonstrate that incorrectly issued patents can survive in the market without judicial review, even when the invention is neither novel nor non-obvious. We support this contention by presenting a game theoretic model that studies the interaction between the patentee and an alleged infringer/challenger. Using this model, we demonstrate the impact of the transaction costs in the patent system at the administrative stage in the Patent Office and at the enforcement stage in the courts, and highlight the inability in our current system to mount effective challenges to improperly granted patents in the current system. We also evaluate how changes in patent litigation costs and the quality of adjudication in the courts affect the incentives to challenge patents thereby affecting the probability of securing a patent. We show that there is a need to advance new mechanisms to improve the administrative processes employed by the Patent Office. Specifically, we support including administrative challenges, such as patent oppositions, in order to improve Patent Office functioning by correcting and limiting the number of improperly granted patents. We describe and analyze the characteristics of such an opposition system, including the costs of such a process, the timing of the process with respect to patent issuance, and the scope of the estoppel granted to such a process for both subsequent oppositions and court challenges to the patent. We conclude that a low-cost, post-grant, opposition process based primarily on written submissions with a limited estoppel effect and administered by Administrative Opposition Judges (AOJs) will serve as an effective instrument for improving the quality of patents that are issued and enforced. In other words, including these incentives for producing better quality patents will decrease the number of incorrectly issued patents. These incentives will improve overall social welfare thereby reducing the incentives for strategic conduct and aggressive patenting in many technology areas. Finally, we present empirical results from an exciting patent reform experiment taking place in Japan in the past four years and compare these results to the insights obtained from our model. Since April 2000, Japan has embraced a dual patent invalidation system that permits patent challenges in both the Japanese Patent Office (JPO) and their District Courts. Our empirical data on dual invalidation processes in Japan from 2000-2003 demonstrate that there are sound economic and institutional reasons for maintaining the ability to raise patent validity challenges in both the Patent Office and the courts since both mechanisms are complementary and necessary.

Why 'Bad' Patents Survive in the Market and How Should We Change? - The Private and Social Costs of Patents