Tessera, Inc. v. Int’l Trade Comm’n, 2010-1176 (Fed. Cir. May 23, 2011).

Yesterday the Federal Circuit upheld a decision of the ITC regarding patent exhaustion: Tessera, Inc. v. International Trade Commission. The patent holder permitted its licensees to sell the patented invention and received royalty payments later. When some licensees failed to pay, the patent holder argued that its authorized sales had been transformed into unauthorized sales and thus that the licensees’ customers were infringing the patent. The Federal Circuit rightly disagreed,

These agreements expressly authorize licensees to sell the licensed products and to pay up at the end of the reporting period. Thus, in these agreements, Tessera authorizes its licensees to sell the licensed products on credit and pay later. That some licensees subsequently renege or fall behind on their royalty payments does not convert a once authorized sale into a non-authorized sale. Any subsequent non-payment of royalty obligations arising under the TCC Licenses would give rise to a dispute with Tessera’s licensees, not with its licensees’ customers.

Tessera’s argument that the sale is initially unauthorized until it receives the royalty payment is hollow and unpersuasive. The parties do not dispute that the TCC Licenses permit a licensee to sell licensed products before that licensee pays royalties to Tessera. But according to Tessera, that licensee’s sale, permitted under the TCC License, would later become unauthorized if that licensee somehow defaulted on a subsequently due royalty payment. That absurd result would cast a cloud of uncertainty over every sale, and every product in the possession of a customer of the licensee, and would be wholly inconsistent with the fundamental purpose of patent exhaustion—to prohibit postsale restrictions on the use of a patented article. See, e.g., Bloomer v. McQuewan, 55 U.S. (14 How.) 539, 549 (1852) (stating “when the machine passes to the hands of the purchaser, it is no longer within the limits of the monopoly”).

It is this same absurd result and the same cloud of uncertainty that results after every sale of a copy of software in light of the Ninth Circuit’s worst copyright opinion in decades: Vernor v. Autodesk, 621 F.3d 1102 (9th Cir. 2010). By permitting postsale restrictions on the use of software the Ninth Circuit has adopted a view of the Copyright Act wholly inconsistent with the fundamental purpose of copyright exhaustion–i.e., the first sale doctrine.

Vernor’s counsel has recently filed an excellent brief petitioning for a writ of certiorari, and one can only hope that the Supreme Court will choose to straighten this out so that we can get opinions in the copyright context as cognizant of the harms of ignoring exhaustion principles as this opinion is in the patent context.

When the Supreme Court granted cert on Bernard Bilski’s business method patent application for hedging risks in commodities trading, most commentators thought we would finally get some clarity on the future method patentability.  Some, like myself, hoped that the Court would draw a defining line, such as a rule that patentable methods must be technologically-based or, at a minimum, that human activities and business methods, by themselves, were unpatentable. Others wanted the Court to hand down a definitive ruling that method patenting was wide open, with the main constraints lying in other requirements under the Patent Act such as novelty, nonobviousness, and specificity.

What we got, however, was a mess – a mess of clues and hints as to what is patentable, but no clear line or test. While all nine members of the Court agreed that Bilski’s method was unpatentable and that the Federal Circuit’s exclusive “machine-or-transformation” test was too limited to determine the entire universe of patentable processes, the Court was deeply divided as to the right approach to the issue.

Justice Kennedy’s five-vote majority opinion – which reads more like a concurrence and is quite short (16 pages) for a case that took 231 days to decide – argues that Bilski’s application fails because it is an “abstract idea” and thus not allowed to be a “process” under Section 101 of the Patent Act. Yet Kennedy does not provide much explanation as to why the Patent Act prohibits abstract processes or how one tells the difference between an abstract process and a concrete process. For example, we leave the opinion without any sense of whether or not Judge Sotomayor’s famous “speed dating” example or Justice Breyer’s new method for teaching antitrust law are abstract or concrete. Instead, Kennedy merely states that “[c]oncerns about attempts to call any form of human activity a ‘process’ can be met by making sure the claim meets the requirements of §101” without explaining which requirements would do this or how.

Later, in a part of the plurality opinion that Justice Scalia did not join, Kennedy suggests that “i[f] a high enough bar is not set when considering patent applications for [business tasks], patent examiners and courts could be flooded with claims that would put a chill on creative endeavor and dynamic change.” Kennedy then suggests that the “abstract idea” concept can establish a limiting principle on business method patents “if the Court of Appeals were to succeed in defining a narrower category or class of patent applications that claim to instruct how business should be conducted, and then rule that the category is unpatentable because, for instance, it represents an attempt to patent abstract ideas.” Again, ironically, Kennedy’s approach is rather abstract itself and offers little if any guidance.

So what can we take away from Bilski? Well, besides Justice Stevens’ 47-page tour-de-force concurrence arguing to uphold the historical exclusion of business method patents, here are my top four:

1)   State Street Bank’s “useful, concrete, and tangible result” test is dead.

In the 1998 State Street Bank v. Signature case, the Federal Circuit Court of Appeals opened the floodgates to an explosion of questionable patent applications by allowing patents to cover any subject matter as long as they produced a “useful, concrete, and tangible result.” This was far too broad and part of what lead to the Supreme Court taking Bilski in the first place. In the Bilski decision, four justices explicitly advocate against this standard and the majority opinion goes out of its way to state that nothing in its holding “should be read as endorsing” the State Street interpretation of Section 101: a clear message to the Federal Circuit that this test should go quietly into the history books.

2)   Abstract ideas likely include “basic concepts” and methods that can be reduced to a mathematical formula.

While most of the Bilski opinion is vague about how to define an abstract idea or the appropriate test to use, Justice Kennedy does provide a few more clues when he analyzes the Bilski claim directly. There, he describes the claims at issue as covering “the basic concept of hedging or protecting against risk” – “a fundamental economic practice.” He then writes: “The concept of hedging, described in claim 1 and reduced to a mathematical formula in claim 4, is an unpatentable abstract idea.” Thus, we are left with the suggestion that anything “conceptual” or that can be reduced to a mathematical formula is an unpatentable abstract idea. This may well be a defendant’s best argument when challenging a patent claim in court on these grounds.

3)   Parker v. Flook’s “field of use” and “postsolution activity” limitations are alive and well.

In 1978, Justice Stevens wrote Parker v. Flook, a case about a mathematical algorithm used to update alarm limits for a catalytic converter. In the case, the Court held this was unpatentable because an algorithm was a law of nature, even when the applicant attempted to limit it to a specific field of use or to add insignificant post-solution activity (such as triggering an alarm). In 1981, however, the Court decided Diamond v. Diehr, and called some of Flook’s holdings into question. Some commentators then speculated that Flook’s limitations on patentable subject matter were dead or at least diminished and that Diehr had essentially quietly overruled Flook.

While Kennedy cites to both Flook and Diehr in the Bilski opinion, he emphasized Flook much more heavily and suggests that its two major limitations could be among the most useful for the PTO or courtroom defendants who want to challenge patent claims as abstract ideas and especially those merely hitched to a concrete term here and there. So there is no question, Flook is alive, well, and good law.

4)   Expect more Section 101 challenges, especially at the early stages of patent litigation.

Under the State Street Bank test, very few patent litigation defendants had incentive to bring a challenge under Section 101 to a method claim, as it was almost impossible to prove that a patent had absolutely no “useful, concrete, and tangible result.” Now, even with the vague formulations offered by the Court’s opinion in Bilski, there will be more hope for patent litigation defendants to challenge broad method claims in court as abstract ideas. Two key reasons to do so are cost and timing. In patent litigation, defendants are often dragged through courts for years, even on bogus or bad patents, because proving a patent was obvious or that someone else had invented it first is expensive, time-consuming, and fact-intensive.

Arguing that a patent claim is an abstract idea, however, could be much simpler. While litigants might want to include some facts and expert testimony, others might simply want to challenge the patent claims as abstract on their very language. This is certainly how the Court in Bilski decided the abstractness question, and how the courts in Flook and Diehr did as well. Under this approach, defendants could even bring a motion to dismiss the case at the initial pleading stage, before any burdensome discovery and other litigation costs are incurred. This could also result in more decisions that interpret Bilski coming out at a relatively fast pace and providing the additional guidance litigants will need to navigate this new approach.

For others’ analysis, see here, here, here, and here.

One last note: As a result of the Supreme Court’s ruling, we will be moving this case off the Top Ten list. However, given that the Court left so many issues open and raised so many new questions, I still think the issue of method patentability for technologies such as software, medical diagnostics, and other information innovations is still very much up in the air and in play. We will be watching cases such as Prometheus v. Mayo to see how the Federal Circuit and other courts respond. But I anticipate this issue taking years to work out.

Prof. Pamela Samuelson and I filed a brief in support of this position on behalf of the Kauffman Foundation, EFF, Public Knowledge, MIT business professor Eric von Hippel, and several well-known technology entrepreneurs. The brief urges the court to affirm the rejection of the Bilski application for three reasons: (1) the history and structure of § 101 limit the construction of “process” to technological processes (which we define), (2) allowing patents on non-technological processes such as those in the business and service industries is unnecessary and harmful to innovation, and (3) removing the long-standing technological limit on § 101 processes would undermine the institutional competence of both the PTO and the federal courts to protect innovation.

EFF has done a blog post on the brief and the case here.

Briefs in support of Bilski’s position can be found here.

I will try to post links to various briefs as they come in.

To start, you can find the Redhat brief here.

UPDATE: Patently-O has most of the amici supporting the USPTO here.

In sum, it argues that United States patent law only protects “industrial and technological” processes and not methods, like Bilski’s method of hedging financial risk, that are “untethered to technology.” Amicus briefs in support of the PTO’s position are due this Friday, Oct. 2. I plan to file one and will post a link to it and others when they are public.

In re Bilski (Fed. Cir.), on appeal to the Supreme Court as Bilski v. Kappos.

Background:

In 1997, Bernard Bilski and Rand Warsaw filed a patent application claiming to have invented a novel method of hedging risks in commodities trading. In the primary claim, the only steps employed consist of (1) identifying market participants and (2) initiating various series of financial transactions. The claim does not require any specific technologies or physical methods of implementation.

The Patent and Trademark Office (PTO) examiner rejected the Bilski claim under Section 101 of the Patent Act, finding that because the method lacked any specific grounding in an apparatus, it was not tied to the “technological arts” and thus unpatentable. The PTO Board of Appeals also rejected the patent under Section 101 but focused its reasoning on the lack of physical transformation resulting from the method. Both the PTO examiner and Board also claimed Bilski’s method was too abstract to be patentable.

Upon review by the Federal Circuit Court of Appeals, the case was decided en banc. In the somewhat fractured set of opinions, the majority held that Bilski’s application failed because it did not pass Section 101’s “machine-or-transformation” test. The Court identified this test after reviewing numerous Supreme Court and prior Federal Circuit opinions, concluding that the trigger for patentability for a method was either its implementation on a machine or that it somehow transformed matter into a different state or thing. Bilski subsequently petitioned for certiorari, which was granted for the 2009-2010 term.

A little history:

In the 1970s and 1980s, the Supreme Court took on the challenging issue of patentable subject matter for methods, deciding three key cases – Gottschalk v. Benson (binary decimal conversion methods),¹ Parker v. Flook (a method for updating alarm limits on a catalytic converter),² and Diamond v. Diehr (a method of determining the ideal temperature and time for curing rubber).³

In those cases, the Court struggled with the difference between so-called “abstract” mathematical algorithms and pragmatic methods of improving technology that used newly discovered algorithms as their key advancement. In Benson and Flook, the Court rejected the methods at issue, but in Diehr, it allowed them, claiming that because the purpose of the method was to transform rubber, a quite tangible thing, it was patentable.

After Diehr, the Federal Circuit (and its predecessor court) also struggled with limits in this area issuing numerous conflicting decisions with numerous tests. Finally, in 1997, the Court decided State Street Bank v. Signature Financial,⁴ where it held that Section 101 applied broadly to method patent claims, and that as long as the method produced some “useful, concrete, and tangible result”, it was patentable. This case was particularly controversial because it involved a so-called “business method” patent that claimed a financial investment strategy.

Since then, the Supreme Court has largely been silent as to patentable subject matter for methods. The only exception was Lab. Corp. v. Metabolite,⁵ where after granting certorari, the Court dismissed the case as improvidently granted after discovering the Section 101 issue had been waived below. In dissent, however, Justice Breyer (joined by Souter and Stevens) argued they should take the case and decide it because of the lack of grounding in and uncertainty arising from the Federal Circuit’s State Street Bank decision and its progeny.

What’s at stake:

Simply put, the future of method patentability. In Bilski, the Supreme Court has a daunting task ahead of it. It must somehow decide where to draw the line between invention and abstract idea. The placement of this line could have a dramatic effect on any number of industries, from software to financial to pharmaceutical.

Some argue that for this reason, Section 101 should be defined as broadly as possible and that the PTO and the Courts should use the other requirements for patents (such as novelty and nonobviousness) as gatekeepers on patent quality. Others argue there must be limits and Section 101 plays an important and required role in imposing them. Some agree with the “machine-or-transformation” test; others don’t.

One thing is for certain; given the Court’s recent history of reviewing and rejecting the Federal Circuit’s attempts to set patent policy, it is likely that the Court will fashion its own standard for Section 101, much like in the KSR v. Teleflex⁶ case on obviousness.

See also:

• Peter Zura, Bilski at the BPAI – What a Mess (Part 1) , The 271 Patent Blog (Jun. 16, 2009).
• Dennis Crouch, Bilski v. Doll: Reconsidering Patentable Subject Matter, PatentlyO (Jun. 1, 2009).
• Joe Mullin, Method Men? Handicapping Bilski at the Supreme Court, The Prior Art (Jun. 1, 2009).
• Kevin E. Noonan, The Supreme Court, In re Bilski and the Lingering Question of Labcorp v. Metabolite, Patent Docs (Jun. 1, 2009).

Footnotes

1. Gottschalk v. Benson, 409 U.S. 63 (1972).
2. Parker v. Flook, 437 U.S. 584 (1978).
3. Diamond v. Diehr, 450 U.S. 175 (1981).
4. State Street Bank & Trust Co. v. Signature Fin. Group, 149 F.3d 1368 (Fed. Cir. 1998).
5. Lab. Corp. of Am. Holdings v. Metabolite Labs., Inc., 548 U.S. 124 (2006).
6. KSR Int’l Co. v. Teleflex Inc., 550 U.S. 398 (2007).