Fixing the U.S. Patent System

For most of us, a billion dollars is a lot of money.

I use the phrase “for most of us” because, according to Alpha magazine (April 2007), last year three hedge fund managers each took home well in excess of $1 billion (yes, Billion with a “B”).

Here’s another number for you: in total, the top 25 earners on Alpha’s list pulled in more than $14 billion in 2006, equivalent, the magazine reported, “to the GDP of Jordan or Uruguay.”

In case you were wondering, the mega-earners were James Simons of Renaissance Technologies ($1.7 billion), Kenneth Griffin of Citadel Investment Group ($1.4 billion), and Edward Lampert of Sears Holdings ($1.3 billion).

For the rest of us, whose W-2 forms do not have a 10-digit number in the box labeled “income,” the dollar amounts involved in two patent infringement cases over the past year seem astonishingly high. In February, a California jury ruled that Microsoft must pay Alcatel-Lucent $1.52 billion for infringing two MP3 audio compression patents in software added to Microsoft’s Windows Media Player. (Microsoft plans to appeal the decision to the U.S. Court of Appeals for the Federal Circuit in Washington state).

This action follows last year’s $612.5 million settlement between Research in Motion (RIM) and NTP. To avert a possible court-ordered shutdown of its BlackBerry system, RIM paid the equivalent of a year’s worth of revenue to the small Virginia-based patentholding firm, which had sued RIM claiming the BlackBerry infringed on several of its patents.

Stung by the scope of these awards, the high tech community has gone on the offensive in calling for reform of the U.S. patent process, which has long been criticized as stifling rather than promoting innovation while serving to elicit lawsuits that extort large settlements.

At the heart of the matter is the United States Patent and Trademark Office (USPTO), an agency commonly described as overwhelmed and unable to keep pace with new and developing technology. As of mid-2005, the average length of time it would take to reach a first action on the merits of a new application in the area of control circuits was 44 months, for computer security it was 39 months, and for medical instruments 46 to 54 months.

In all, there is an estimated backlog at USPTO of over 675,000 patent applications, a number that is expected to rise to nearly 800,000 by year’s end. While funding for the USPTO has increased in recent years allowing the agency to hire 1,200 new people per year to its patent examiner corps, legislative changes are also needed.

Congress to the rescue?

In an attempt to fix things, on April 27 legislation was introduced in both the House (H.R. 1908) and Senate (S. 1145). The proposed bills are together referred to as the Patent Reform Act of 2007. Here’s a snapshot of what this legislation is attempting to do:

Change the U.S. patent system from a first-to-invent standard to a first-to-file standard. The United States stands alone among nations that grant patents in giving priority for a patent to the first inventor as opposed to the first to file a patent application for a given invention. Most other countries consider the first person to file an application as the rightful inventor and “patentee,” to use a legal term. These countries also require a patent application to be filed before you can publicly divulge the existence of the invention.

In a step toward international harmonization, the patent reform legislation under discussion would replace current law with a “first-to-file” system. In the past, the U.S. method also has offered a one-year grace period giving inventors a chance to test their ideas in the marketplace. The current legislation maintains this grace period for inventors who have previously disclosed the subject matter of the invention.

Balance the apportionment of damages. As suggested by the $1.52 billion award Alcatel-Lucent obtained against Microsoft, damages for patent infringement have skyrocketed. The new bills requires that courts, in calculating damage, take into account just the fair share of the patent’s contribution to the value of a product and not the value of a whole product that has many other components.

Microsoft said the damages in its case were calculated by multiplying Windows sales volumes and PC sales prices worldwide since May 2003. It is interesting to note that damages were calculated using the average cost of a PC rather than the cost of Windows–even though Windows was the infringing software in question. About half of the Alcatel-Lucent award came from overseas damages. Patent revisionists have argued that companies should not be held liable in U.S. courts for worldwide damages from acts of infringement that are claimed to have occurred in other countries.

In a hearing before the U.S. House of Representatives Subcommittee on Courts, the Internet, and Intellectual Property (April 26, 2007), John R. Thomas, Professor of Law, Georgetown University Law Center, pointed out that in the case of Bose Corp. v. JBL, Inc. , the claimed invention consisted of “a particular type of loudspeaker enclosure”–essentially a cabinet in which a stereo loudspeaker sits. “In particular,” Thomas testified, “the patented loudspeaker enclosure featured a ‘port tube’ that allowed some of the acoustic energy inside the cabinet to be released with proper attention to phase relationships, in order to eliminate port noise and increase bass response. When assessing damages against an adjudicated infringer, however, the trial court allowed the royalty base to consist of the entire loudspeaker system, rather than just the infringing port tube.”

Speaking at the same hearing, Anthony Peterman, Director and Patent Counsel for Dell Inc., noted: “Computers and software are examples of system products—they comprise thousands, even hundreds of thousands of individually functioning components and features all assembled in a package for a customer. Because many of these features could be the subjects of a patent—or a number of patents—it is often the case that thousands of patents may be relevant to a particular computer or software product.” Too often, he concluded, “what is supposed to be an award of reasonable royalty is based not on the innovation, or even the feature of which the innovation is a part, but rather on a system as a whole that contains that and dozens or hundreds of other innovations.”

While electronic hardware and software can include numerous patented components usually only a handful of patents are filed for each new pharmaceutical or biotechnology product. As such, these manufacturers and their industry associations are not quite as hungry as electronics firms to radically alter patent damage assessments.

The cost to develop a new biotechnology product is now estimated at $1.2 billion, according to a study by the Tufts Center for the Study of Drug Development. Similarly, pharmaceutical companies argue that one drug can cost up to $1 billion to develop and that earning a return on an investment of that magnitude requires the strongest and longest patent protection possible.

Not surprisingly the biotech/pharma industries are concerned that one result of H.R. 1908/ S. 1105 could be to diminish the value of their patents and the investments predicated on them.

These industries further argue that its inventions are entitled to the same patent term as inventions in other technologies. However, due to the added step of Food and Drug Administration (FDA) regulatory review, biotechnology inventions and new pharmaceuticals lose eight to ten years of patent life. As a result advocates and lobbyists for these industries want day-for-day restoration of all patent terms lost due to regulatory delays.

Restrict shopping for a favorable trial venue. This means placing the patent dispute in a court that has a reasonable geographic connection to the case and not one that historically has been known to have patent-friendly juries. It is an unlikely coincidence that in 2006 over 230 patent lawsuits were filed in the small town of Marshall, TX, 150 miles east of Dallas near the Louisiana border. Part of the U.S. District Court for the Eastern District of Texas, more patent cases were filed in Marshall than were filed in federal district courts in Chicago, New York, San Francisco, and Washington D.C. Why? According to LegalMetric, a St. Louis-based firm providing analytical information concerning federal litigation to the legal, business and financial communities, patent holders won nearly 80% of the time in Marshall’s court.

Recently, Marshall was the venue for patent-related suits filed by Texas MP3 Technologies against Apple, Samsung, and Sandisk. It is also the site of HP v. Acer , Laser Dynamics Inc. v. BenQ, and Qualcomm v. Nokia , to cite just a few. To discourage forum shopping, the patent reform bill requires patent actions to be brought in the district where either party resides or where the defendant has committed acts of infringement and has a regular place of business (a corporation resides either where its principal place of business is located or where it is incorporated).

Provide a window for post-grant patent challenges. The Patent Reform Act also calls for a new procedure for challenging the validity of a patent. Known variously as “revocation” or “oppositions,” this administrative process in the USPTO will provide a means by which parties can promptly (within months of the patent’s issue) challenge the validity of a patent on any ground, but with protection for inventors against frivolous challenges. The legislation requires the director of the USPTO to prescribe rules to protect against abuse of the new post-grant opposition procedure.

Establish fair standards for willful infringement damages. According to the new legislation the awarding of punitive, treble damages for “willful” patent infringement should be reserved only for when there is truly egregious conduct. This would serve to discourage patent holders from indiscriminately issuing infringement warnings and licensing letters in an attempt to demonstrate willful infringement. The bill also would put limits on a court’s authority to find willful infringement.

Join a team

The debate over patent reform has big business choosing sides, forming several like-minded groups in a lobbying attempt to influence the outcome of Congressional law-making. Following is a brief review of the main players and their key positions.

The Coalition for Patent Fairness was formed by Intel, Microsoft, Micron Technology, and 70 other companies in financial services, technology, energy, manufacturing and media industries. The Coalition’s members also include Apple, Chevron, Cisco Systems, Comcast, Dell, Electrolux, HP, Oracle, Time Warner, and Visa.

Of the companies listed, you might be surprised to learn that Micron Technology, a provider of CMOS image sensors and memory products, has become an intellectual-property giant. In total, Micron has secured more than 15,500 issued patents from the USPTO and other international patent offices. Micron itself was the recipient of a $288 million patent settlement with Toshiba for an infringement case first brought on by Lexar Media prior to its acquisition by Micron.

The Coalition for Patent Fairness strongly supports the Patent Reform Act of 2007. “The comprehensive changes proposed in the Patent Reform Act of 2007,” said Jonathan Yarowsky, counsel to the Coalition, “will strengthen and restore balance to the patent system-–legislative action that has been urgently needed for years.”

The Biotechnology Industry Organization (BIO) was founded in 1993 to represent biotechnology companies at the local, state, federal and international levels. BIO’s membership consists of more than 1,100 biotechnology companies, academic centers, state and local associations, and related enterprises.

In a statement released after patent reform legislation was introduced, BIO welcomed the bills, but added, “Unfortunately, the ‘Patent Reform Act of 2007,’ as introduced today, also contains provisions that will weaken the enforceability of validly issued patents, and fails to include necessary reforms to make the patent system more objective and efficient.” In particular, BIO cautioned that the bills “would create a new post-grant opposition system, under which a patent is given no presumption of validity and could be broadly challenged administratively throughout its term–even years after the patentee and the public have come to rely on it, and years after biotech companies have invested hundreds of millions of dollars to bring a patented invention through clinical trials and regulatory approval. Under such a scheme, patents will have less value and investment predicated upon them will diminish.”

BIO isn’t alone in its angst about provisions of the Patent Reform bills. The Coalition for 21st Century Patent Reform has over 40 members including Abbott Laboratories, AstraZeneca, 3M Co., Baxter Healthcare Corp., Bristol-Myers Squibb, Caterpillar Inc., Corning, Dow Chemical, Eastman Chemical, General Electric Co., GlaxoSmithKline, Johnson & Johnson, Eli Lilly and Co., and Procter & Gamble Co.

The coalition supports a number of measures in the patent reform bill that would change the U.S. law, including the creation of a first-inventor-to-file system, expanding the opportunity to submit prior art to patent examiners, limiting willful infringement, and extending prior user rights.

In his testimony on behalf of the Coalition before the House Judiciary Subcommittee Gary Griswold, President and Chief IP Counsel of 3M Innovative Properties Company, said there are several aspects of the bill that the coalition believes “must be improved.”

“Regarding the apportionment of damages,” Griswold testified, “while we are pleased that a ‘reasonable royalty’ remains the floor for damages awards, we are troubled by the proposal to change the law because some believe that the awards against adjudicated patent infringers are ‘excessive.’”

Limiting damages for patent infringement, Griswold added, “tilts the balance in favor of infringers, at the expense of American researchers and innovators. It has profound implications for our system of intellectual property law.”

It’s little wonder that 3M feels this way. Griswold himself pointed out that the company’s patent on Post-it Notes would have much less value if juries had to disregard the value of the pre-existing inventions of paper and adhesive.

The Innovation Alliance has urged the House Judiciary Committee’s Subcommittee on Courts, the Internet and Intellectual Property to hold additional hearings and focus its legislative efforts on reforms to improve the quality of approved patents rather than embracing reforms that undermine the certainty and enforceability of all patents. Members of this group include Amberwave, Cantor Fitzgerald, LSI Logic, Qualcomm, Intemolecular, and Tessera.

In particular, the Innovation Alliance has problems with The Patent Reform Act’s language to create a new post-grant opposition system under which the validity of a patent would be open to administrative challenge throughout the life of the patent. Additionally, in the instances when patent infringement is found, they don’t like the fact that the new bill would remove discretion and flexibility from the courts in calculating damages.

“The creation of a new post-grant review process and the desertion of a market-based system for calculating damages would severely undercut patent-dependent technology companies by bringing new uncertainty to patents,” said Eric Thomas, spokesperson for Innovation Alliance.

Finally, in a related matter, at the end of April the Supreme Court, ruling on the KSR Intl. Co. v. Teleflex Inc. appeal, rendered a decision that will enhance patent quality by ensuring that patents are not issued on combinations that are “obvious.” In its ruling, the court cautioned against granting patents for a combination that only unites old elements with no change in their respective functions, and one that would have been predictable given the existing state of the industry.

But while this “obviousness” test will help to ensure that patents are not issued in cases where the product does not really contribute to the state of the art, the need for substantial patent reform will ultimately require legislative action. Both the House and Senate bills are in the first step of the legislative process and currently sit in the respective judiciary committees. It’s still early in the game, but we’ll keep watch and let you know what happens. ■

Murray Slovick