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NPEs and Abstract Patents

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Patent attorneys like to argue that the U.S. patent system is the envy of the world, the "gold standard" by which all others are judged. While this may be the view of other patent attorneys around the world, policymakers have viewed the U.S. patent system with growing skepticism after the 1998 State Street decision authorized patents on business methods. Since State Street seemed to make it clear that U.S. patents were no longer limited to technology, the US even threatened to walk out of patent harmonization negotiations if the rest of the world didn't agree. That was in 2002, at a high-water mark of national arrogance, but even then we were seeing patents (exercising cats, crustless sandwiches, toilet reservation systems, one-click ordering) that the general public could understand and snicker at as proof of another demented bureaucracy gone off the rails.

That same year, 2002, the Federal Trade Commission and the Department of Justice held a remarkable series of hearings on the interaction of the patent system with competition and innovation. The hearings showed that while pharma and biotech were generally pleased with how the patent system was working, much of high-tech was not, especially software and Internet companies. This unprecedented division in perspective presaged the inter-industry debate has stalled patent reform, despite the twin bi-partisan bills introduced in both houses of Congress in early 2007.

The FTC Takes Another Look

On December 5, the FTC launched a new series of hearings to examine what has changed since 2002 and what impact a dramatic series of Supreme Court rulings may have had. I was on the opening panel, which focused on business models. Also on the panel was Peter Detkin, who was with Intel in 2002 when he coined the term "troll" as a polite alternative to "extortionist," and is now with Intellectual Ventures, the secretive patent aggregator that I wrote about in my last entry.

Our panel avoided the common T-word. The clinically polite alternative is "non-practicing entity," or NPEs -- although that includes upstream technology companies that are not necessarily as opportunist as trolls. Or as legally culpable as extortionists. Isn't it gratifying that patent discourse is becoming more polite -- or at least more circumspect?

I expanded on the patent bubble theme, describing two different kinds of patent value. First, there is the relatively low value of each individual patent in large portfolios developed by large companies for cross-licensing with competitors and defensive use. These portfolios give their owners what is called "freedom of action" or, more modestly, "freedom to operate."

Then there is the high value of individual patents in the hands of specialists skilled in "value extraction" and who don't need to offset the value of their patents with licenses from others because they produce nothing. They don't even have to worry about reputation; they are free to go after inadvertent infringers, with no compunctions and no downside, because they have little to lose. We believe in the efficient division of labor, don't we? So why shouldn't we have patent companies without the distraction and carrying costs involved with real technology and technologists.

But how do we tell the good guys from the bad? Intellectual Ventures says that it has never sued anyone, and it claims its own state-of-the-art invention laboratory. But has it commercialized any meaningful inventions of its own? Not that we've seen yet. Has it strong-armed companies into investing in IV as part of a compelled licensing of IV patents? Nobody's talking because they're all bound by non-disclosure agreements.

Despite the contention around NPEs, it was nice to see that we all agreed that more data is needed and that the patent system should be more transparent. There even seemed to be agreement in principle that patent licenses should be publicly registered. Patents are public instruments after all - shouldn't we know how they are being used, or abused? Wouldn't it be nice to know that NPEs are really engaged in technology transfer -- and are not just threatening operating companies after they create and market products?

Unfortunately, there is little transparency in today's patent system. Indeed, the patent system is beset by information failure. Information on the existence, interpretation, validity, and valuation is costly and uncertain -- much more so for some than others. This information asymmetry leads to arbitrage. And arbitrage means that low-value uses (e.g., individual patents in large cross-licensed portfolios) will migrate to high-value uses. The highest value is in the hands of trolls, since they are specialists who do not have to offset the value of their patents with a need to license the patents of others. They can assert patents without fear or inhibition, a very attractive use that increases the value of patents, builds demand for more patents -- in short, creating a bubble for patents that threatens those that produce complex products and services for real markets.

Deflating the Bubble... Slowly

Two months ago, the Bilski decision came down from the Court of Appeals for the Federal Circuit, the patent appeals court that issued the State Street decision ten years before. (Bilksi was a pure business method; see background here and here.) The court declined to overrule State Street or reinstate the old exception for business methods, but it abandoned the test it used in State Street. All State Street required was "a useful, concrete, and tangible result," language that the court concocted itself in a case four years earlier. The court never defined what these words meant, and it never found an application or patent that didn't meet this "test," so everyone assumed that this meant that anything was patentable.

Sobered perhaps by a string of Supreme Court reversals that seemed to strike at the heart of its original patentee-friendly jurisprudence, the Federal Circuit in Bilski abandoned the undefined, homegrown test in State Street as inadequate and recrafted a test from Supreme Court precedent:

For a process to be patentable, it must involve a physical transformation to a different state or thing, or must be tied to a particular machine.

What does that mean? The court gave examples indicating that software would be patentable if it represented physical objects undergoing physical transformation. However, it expressly reserved judgment on the alternative test: whether a general-purpose computer was "a particular machine." If so, of course, all software processes would be patentable.

Not the brightest of lines, but the court didn't flinch from trying to draw one, despite arguments that patent lawyers would manage to circumvent any court-imposed limitations. The Bilski decision leaves a lot up in the air, but it affirms that judges will draw limits, even around patentable subject matter, and it offers a modest deflating of the patent bubble. It eliminates some of the worst excesses spawned by State Street without provoking a backlash. And it has breathed new life into public debate of where the limits should be. For those who care about how and where the line should be drawn, some colleagues and I have organized a conference at the Brookings Institution on January 14, the Limits of Abstract Patents in an Intangible Economy.

Just as the debate has come alive in the U.S., it has also resurfaced in Europe three years after a proposed directive on software patents went down to defeat in the European Parliament. The President of the European Patent Office has asked the EPO's Enlarged Board of Appeals to answer four questions about the patentability of computer programs. The European Patent Convention has always specifically precluded patents on certain abstract processes, including computer programs and business methods, but then in the next section it says that these exclusions only apply to computer programs, etc. "as such." So decades have been spent trying to figure out what "as such" really means and what kind of "technical" contribution is needed to pass muster. Confronted by a proposal from the European Commission to reaffirm EPO rulings on computer program patentability, Europe spent 3 ½ years in passionate debate about software patents before the European Parliament killed the process by a vote of 648 to 14..

Can we draw a line against abstract patents? That's clearly not the kind of semantics that a right-thinking legislative body would want to wade into under its own free will. But courts have to decide cases that are brought before them, even the tough ones, and my guess is that they will continue to do so, as messy as it may be.