ABA Section of Business Law

The click heard round the world

By SHEILA M. RYAN and JOHN M. BAGBY

I t’s a dot-com world. Not just for 20-somethings wanting to make a million and retire by 30 but increasingly for judges, lawyers, patent examiners and even possibly business lawyers. From Silicon Valley to Wall Street, the new whisper word is MODB: methods of doing business patents. What are these MODBs and why are they creating a stir? Not knowing the answer to this question can be costly to lawyers, corporate counsel and prospective clients.

Fueling the renewed interest in patent law is a monumental case, State Street Bank & Trust Co. v. Signature Financial Group Inc., 149 F.3d 1368 (Fed. Cir. 1998); cert. denied, 119 S. Ct. 851 (1999). State Street is remarkable because it, along with AT&T Corp. v. Excel Communications, 172 F.3d 1352, (Fed. Cir. 1999) removed two judicially created exceptions to subject matter that is eligible for patent protection — mathematical algorithms and business methods. This double punch upset the patent bar and opened worlds of opportunity for America’s new technology-driven economy.

Twenty years ago, it was believed, under separate lines of reasoning, that neither computer software nor methods of doing business were eligible for patent law protection. Over time, these beliefs eroded and now in the era of State Street and Excel, both "inventions" are patentable. And maybe even more exciting for Silicon Valley dwellers is the possibility of protecting the combination: methods of doing business embedded in computer software.

The purpose of patent law is to promote and support innovation by granting limited monopolies to inventors. Subject matter eligible for patent protection includes "…any new and useful process, machine, manufacture or composition of matter, or any new and useful improvement thereof…" 35 U.S.C. § 101. Historically, the Supreme Court has interpreted this provision broadly. Balancing this broad inclusion are three categories of unpatentable subject matter: laws of nature, natural phenomena and abstract ideas. Diamond v. Diehr, 450 U.S. 1775 (1981).

For many years, debate raged over just what was eligible for patent protection until Judge Rich in State Street presented clarity, albeit controversial clarity, to the debate. At issue in State Street was a patent for a hub-and-spoke system for managing investment funds. The patent was assigned to Signature Financial Group, which had entered negotiations with State Street Bank to license the patent. Negotiations broke down and State Street retaliated by bringing a declaratory judgment action claiming that the patent was invalid because the subject matter was not eligible for patent protection because it included a mathematical algorithm.

The district court agreed with State Street’s argument, and invalidated the patent not because it was a mathematical algorithm but rather because it was a business method and thus not entitled to patent protection. The Federal Circuit, the premier panel for patent appeals, reversed and remanded, holding that business methods claims are eligible for patent protection.

It was long believed that methods of doing business were not eligible for patent protection because of a 1908 case, Hotel Security Checking Co. v. Lorraine Co., 160 F. 467 (2d Cir. 1908). Hotel Security involved a patent claiming a method of cash registering and account checking. Basically, slips of paper were assigned to each waiter, along with a unique number, and both were used to track orders and receipts controlled by the cashier.

Because the court, in dicta, likened the system to bookkeeping, and subsequently held the patent invalid, the case was later misinterpreted to mean that methods of doing business were not patentable. However, patents subsequently invalidated under the so-called business methods exception were really found invalid on grounds of novelty or nonobviousness; two required hurdles that patent claims must pass for patent eligibility.

Before State Street, lawyers and business method inventors relied primarily on the trade secret system and copyright law to protect their novel methods of doing business. Many companies, however, simply sought no protection at all. The result was that novel business methods proliferated in the public domain, losing forever patent protection because the patent system does not protect inventions that have been in the public domain.

The second judicially created exception to patent protection is the mathematical algorithm exception. This exception was derived from the statutory exclusion for "abstract ideas." It was believed that mathematical algorithms were merely abstract ideas that could not be patented. This barrier was lowered in the 1994 Federal Circuit decision In re Alappat, 33 F.3d 1526 (Fed. Cir. 1994), holding that mathematical algorithms are part of a patented claim if there is a "useful, concrete and tangible result" from the algorithm.

In State Street, Judge Rich used Alappat to clarify the debate surrounding mathematical algorithms by noting that the machine in Alappat transformed data through a series of mathematical calculations to produce a waveform display on a monitor (rasterizer). The smooth waveform — a concrete and tangible result — elevated the mathematical algorithm involved in the patent claim from a mere abstract idea to something that was entitled to patent protection. Rich went further by saying that the dollar amount computations in State Street could constitute the type of data that could be transformed into a useful result.

The result in State Street was a final share price that could be used for various purposes. By linking the final share price with the waveform in Alappat, Judge Rich was able to bring the claim within the protective arms of patent law.

Then, in 1999, the Federal Circuit sent a strong signal to the patent bar and the e-commerce industry when the court in Excel stated that the law has the ability to "…adapt to new and innovative concepts…" and be "responsive to the needs of the modern world…" The court was responsive to those needs in Excel when it held that a mathematical algorithm encased in a method or process claim is eligible for patent protection. This means that the scope of patent eligible subject matter is not limited by the form of a claim. The court also held that physical transformation is not an absolute requirement for protection but simply an example of how a mathematical algorithm could produce a useful result.

By expanding the scope of patent protection to process or method claims and removing the "believed" requirement for physical transformation, the court gave a huge boost to the fortunes of start-up companies in Silicon Valley, so many of which are devoted to software creation and its relevant application. The practical result of Excel is that most computer software is eligible for patent protection.

News of the potential implications of State Street and Excel quickly spread through the software industry, and entrepreneurs seized the opportunity to establish intellectual property (IP) monopolies. Estimates indicate that filings in the 705 patent class, which encompasses most MODBs, have increased 700 percent since the State Street decision. Clever entrepreneurs like Jay Walker of Priceline.com have started businesses predicated on the strategy of obtaining these new patents and spinning them off into separate businesses. Patent examiners are overwhelmed with the volume of filings and the PTO examination process time for these patents has increased significantly.

Along with the increased filings have come increased criticisms, from both academics and business. Legal scholars generally agree that the business methods exception was at most a deterrent because no patent was ever invalidated based solely on the exception. No one has quantified, however, the chilling effect that the exception created, and where it had its greatest effects. How many business methods that were eligible for protection were left unprotected because companies were advised that it was a waste of time, and that the better course was to seek protection through the trade secret system?

That leads to another criticism of the potential impact of the State Street decision. Because companies cloaked their business practices in secrecy, the prior art needed to test the novelty of MODB patent claims is sparse, arguably permitting patent issuances for business practices that have been in use for years. For example, many argue that Priceline.com is just a clever Internet adaptation of the reverse auction — a process that has been around for decades.

Commentators claim that granting MODB patents will stifle innovation rather than promote it. That is an ironic effect since innovation is the foundation of patent law. Some giants in the industry agree. Jeffrey Bezos of Amazon.com says that MODB and software patents are fundamentally different and thus should not be granted the full 20-year protection period. Bezos advocates a protection period somewhere in the range of three to five years.

Despite his comments, Amazon.com continues, along with its competitors, to file scores of applications for the "new" patents, as well as wield newly issued ones against their foes. Particularly criticized is Amazon’s injunction against Barnes & Noble for their use of Amazon’s patented one-click technology, even though Amazon’s patent is currently being challenged.

Not surprisingly, the injunction was requested and granted right before the crucial December 1999 holiday shopping season. This incident highlights how companies are using MODBs as part of their business strategy to hinder the activities of their competitors.

The U.S. Patent and Trademark Office (PTO) has heard the complaints and is taking significant steps to address the concerns. On March 29, 2000, the PTO issued an action plan as part of their Business Method Patent Initiative. The plan consists of two elements: industry outreach and improving the quality of the patent examination process.

As part of the industry outreach, the PTO proposes to form partnerships with the software, Internet and e-commerce industries to discuss concerns and solutions to common problems. A roundtable discussion held last July brought comments from various members of the community, including the general public.

Also, the PTO wants help building its prior art data from the involved industries. Prior art is seen as the lynchpin in the whole problem, because a broad and comprehensive database of prior art should limit the number of bad patents being issued, and allay the fears of many companies.

From a quality standpoint, the PTO wants to enhance technical training, revise examination guidelines and expand current search activities for the patent examiners. There is no time frame for the action plan, but PTO regulations are beginning to emerge. For example, a new rule more clearly empowers PTO examiners to require the applicant’s submission of relevant prior art, 37 C.F.R. Section 1.105. Presumably, the intensity of the interest in this area will prevent the PTO from dragging its feet on the subject, unless proposed budget reductions cut into this effort. There is also concern that Congress will step in and tackle the issue more extensively than they did in the recently passed American Inventors Act.

The American Inventors Protection Act of 1999 was part of the Intellectual Property and Communications Omnibus Reform Act. One of the more notable provisions of the act is the First Inventor Defense, which deals directly with some of the criticisms leveled against the patent system in the wake of the State Street decision.

The rationale behind the defense is that latecomers to the e-commerce industry could destroy established businesses because they were the first to obtain the patent even though the business practice had been in use for some time. The act allows a party to defend a patent infringement claim by proving that the subject matter of the challenged MODB patent had been used for at least one year prior to the filing of the patent application.

It is unclear how effective the First Inventor Defense will be or if it will be expanded. The passage of the act shows that Congress is aware of the problems inherent with MODBs. It is conceivable that intensified lobbying could lead the lawmakers to go beyond the First Inventor Defense and revoke MODBs as patentable subject matter, or place severe limitations on patent eligibility and MODB patent terms. In fact, in October 2000, two congressmen sponsored a Business Methods Patent Improvements Act (HR 5364) aimed at improving the quality of MODB patents.

Not wanting to see legislative interference on the MODB issue is the ABA’s Intellectual Property Law (IPL) Section. At their meeting last June, they debated several resolutions relating to MODBs. The IPL is opposed to any amendment or interpretation of Section 101 that excludes business methods from the class of statutory subject matter because they believe that meddling with the patent system will be detrimental to the U.S. economy.

It is not surprising that the patent bar does not want legislative interference on lucrative new opportunities within their turf, however, others — like the high-profile Bezos — have millions of dollars at stake in the new patent battlefield, and are not likely to defer to the patent bar. Backing up Bezos’ position are economists who argue that MODBs will stifle the new economy. It is too early to tell who will win the battle, and the recently proposed HR 5364 indicates that Congress will not just sit idly by.

On the global front, the patent bar is working to achieve an amendment of the European Patent Convention to ensure that software, business method inventions, and other inventions related to electronic commerce, are eligible for patent protection under the Convention, and to harmonize European practice with that in the United States and Japan.

Currently, under the European Patent Convention, there is a per se rule against patent protection for claims relating to business methods or computer programs. Recently, officials of the European Commission have advocated for the removal of the per se rule against computer programs in their "White Paper on Promoting Innovation through Patents." It would be highly ironic if Europe moves toward the wishes of the U.S. patent bar while the U.S. Congress takes the United States one step back. Similar problems exist under Japanese law for MODB patents.

Since the State Street decision, it is fair to say that the PTO is becoming very familiar with MODBs not just because of the increased application volume, but also because of the controversy MODBs have generated and the spotlight that has been focused on the quality of patent examinations. When others feel that the examiners have not done their job, MODB patents are increasingly challenged before judges who can no longer point to the retired MODB exception to invalidate the controversial patents.

Thorny issues, long held silent, are now forced to the surface and judges must deal with them, including the essential question of just what is a method of doing business. No clear legal definition currently exists, but increased litigation or Congress will force its refinement.

Lawyers must aggressively advise their clients about MODBs and the implications of State Street and Excel. Quite simply, the implication is that if you do not get one, someone else will, and it will be used against you. In the business world, it is not just first to market — it is now first to the patent office. Those left out in the cold may face infringement actions, weakened bargaining positions in technology-swapping negotiations or limited access to venture capitalists who rely increasingly on patent assets.

The race in the new economy just got faster, and it will be a rough ride for all involved: business people, judges, as well as the PTO and the business lawyers who traditionally help design novel business-transaction models.

Ryan is a graduate student at the Smeal College of Business Administration of the Pennsylvania State University in University Park, Pa. Her e-mail is: smr253@psu.edu. Bagby is a professor of business law at the same institution. His e-mail is: jwb7@psu.edu.

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