You’ve probably sensed the hunger for an answer if you’ve read this blog at all over the past year. (And if you haven’t, we forgive you.) Everyone, including all nine Supreme Court justices, agreed that Bernard Bilski and Rand Warsaw’s patent application for a method of hedging weather-related risk in energy trading was properly denied by the Patent Office. That much was clear from the November 2009 oral arguments before the Court, in which the querulous justices peppered Bilski’s counsel with business method patent hypotheticals (speed dating, an 80%-effective method of keeping students awake during an antitrust class, a method of maximizing wealth by buying low and selling high, and horse whispering). The hypotheticals were only slightly more absurd than the reality with which businesses have been living since the Federal Circuit suggested in its 1998 ruling in State Street Bank v. Signature Financial Group that methods of conducting business could be patentable if they produced a “useful, concrete and tangible result.”

The Bilski/Warsaw “invention” did not pass the smell test. The question was why? Inquiring technologists and IP lawyers wanted to know.

Abstract Ideas

In the end, the Court splintered. All the justices agreed that Bilski’s patent application taught an abstract idea or principle, and as such, according to well-established precedent, was not eligible for patenting as a “process” under 35 U.S.C. §101. Abstract ideas or principles, laws or phenomena of nature (even if just discovered) and mental processes are not patent-eligible subject matter because they are seen as the basic tools of scientific and technological work, and courts are careful not to permit any single person or entity to preempt their use. (However, as the Court’s opinion noted, the application of such concepts to a known structure or process can be patentable if it is novel, useful, non-obvious when viewed against the prior art and supported by a full and particular description in the patent application.)

All of the justices also agreed that the Federal Circuit had overstepped its bounds by holding that the machine-or-transformation test, which grounded the patentability of processes in their connection to a particular machine or physical transformation) was the sole test for determining whether a process met the threshold requirement for patentability. However, in a true mindbender, they also all agreed that the machine-or-transformation is still relevant, as an “useful and important” clue or investigative tool (in the Court’s opinion) or as a “critical” tool (in Justice John Paul Stevens’ concurring opinion). Of course, the justices could not agree on exactly how the machine-or-transformation test was still important, useful, critical, awesome, etc. In the Court’s opinion, the justices drew a dichotomy between Industrial Age inventions and Information Age inventions and suggested that the machine-or-transformation test might be the proper standard for evaluating processes in the first category, but from my perspective, trying to puzzle out whether a client’s invention is more like a steam engine or a search engine doesn’t seem like a particularly helpful — or intellectually satisfying — inquiry. Ultimately, the Court did not articulate a standard, beyond trotting out the abstract idea trope as a lowest-common-denominator limiting principle.

What About Business Methods?

So where does that leave us? In limbo, dear techies. The lower courts will have to go back to the drawing board to devise new standards for evaluating software and Internet patents. The Bilski opinion — or more accurately, opinions (for there were several concurrences) — do provide a few tea leaves to read. Business method patents survive, but by the skin of their teeth. The Court’s opinion leaves open the possibility that some business methods may be patentable, although the majority is skeptical that they warrant “broad patentability”, and in his concurring opinion Justice John Paul Stevens (joined by Justices Sonia Sotomayor, Stephen Breyer, and Ruth Bader Ginsburg) argued strenuously that business methods should never be patentable.

The relevant part of the Court’s opinion (authored by Justice Anthony Kennedy and joined in by Chief Justice John Roberts as well as Justices Samuel Alito and Clarence Thomas) had this to say with regard to business method patents:

“Interpreting §101 to exclude all business methods simply because business method patents were rarely issued until modern times revives many of the previously discussed difficulties…. At the same time, some business method patents raise special problems in terms of vagueness and suspect validity…. The Information Age empowers people with new capacities to perform statistical analyses and mathematical calculations with a speed and sophistication that enable the design of protocols for more efficient performance of a vast number of business tasks. If a high enough bar is not set when considering patent applications of this sort, patent examiners and courts could be flooded with claims that would put a chill on creative endeavor and dynamic change.

In searching for a limiting principle, this Court’s precedents on the unpatentability of abstract ideas provide useful tools…. Indeed, 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, this conclusion might well be in accord with controlling precedent…. But beyond this or some other limitation consistent with the statutory text, the Patent Act leaves open the possibility that there are at least some processes that can be fairly described as business methods that are within patentable subject matter under §101.”

As previously mentioned, four justices (include three who remain on the Court) have taken the position that business methods are not patentable under any circumstances. It is also worth noting that Justice Antonin Scalia did not join in the portion of the Court’s opinion (quoted above) upholding the theoretical patent-eligibility of business methods. Therefore, at least three, and perhaps four, sitting justices reject business method patents totally, with four others rejecting their “broad patentability” and recommending that a higher bar be set. Notably, too, all of the justices take a dim view of the State Street opinion, with the majority refusing to endorse its perceived blessing of business method patents and Justice Stevens’ concurrence calling it a “grave mistake.” Forget abortion, gun rights and church-state separation: given this volatile mix, Elena Kagan’s views on patent law may assume paramount importance.

What Do I Do Now?

So what should software and Internet clients take away from all of this? Don’t blow your legal dollars on patents if the essential value of your invention or product lies in its algorithm or the fact that it automates or expedites a general business process. Despite the Court’s rejection of the machine-or-transformation test as the exclusive standard for the patent eligibility of processes, the Patent Office will only be emboldened by Bilski to continue its aggressive stance against business methods and software and Internet patents whose claims are broad and general and have only an ethereal connection to hard technology.

In addition, established companies with ample litigation reserves that are approached by patent trolls wielding business method and general process patents should consider the value of an upraised middle finger. If one such company (possibly co-funded by other similarly situated targets) succeeds in getting the troll’s patent invalidated, the troll’s business is vaporized. Accordingly, trolls may choose their targets more carefully from now on, may be more hesitant to follow through on threatened infringement litigation, and may be willing to take a smaller license fee before moving on to the next target. However, because business method patents survive and Bilski provides no concrete guidance for what qualifies as a patent-eligible process, the troll threat is not eliminated.

Towards Patent Act 2.0

Was Bilski worth the wait? I’d have to say no. On the other hand, perhaps the justices can’t be blamed for agonizing over our intellectual property law’s failure to come to grips with non-traditional inventions and the marginalization of brick-and-mortar innovation ecosystems. It’s time, perhaps, for Congress to step in and give us a Patent Act for the post-industrial age.

* Bilski’s patent application for a method of hedging risk in commodities trading was properly rejected because the invention was nothing more than abstract principles and formulae, which are not subject matter eligible for patenting according to prior Supreme Court decisions.

* There is no reason to exclude categorically business methods from the scope of patent eligible subject matter. A business method can be a patentable “process” if it meets the other statutory requirements for patenting (novelty, usefulness, etc.).

Based on my reading of the November 2009 oral argument transcript and my conversations with patent experts, we predict that (1) the Patent Office’s rejection of Bilski’s application for a method of hedging risk in commodities trading will be upheld, (2) the Federal Circuit’s machine-or-transformation test will be invalidated as unduly limiting given the statutory language and history, BUT (3) we may see a new definition of patentable subject matter based upon some ethereal concept of “technology.”

The Supreme Court will next release decisions on Tuesday, June 1. Given the importance of this ruling to our software and Internet clients, we will post a link to the opinion and a brief summary on this blog as soon as it is issued, to be followed by a full analysis not long afterward.

The facts of Stengart are simple. Ms. Stengart brought an employment discrimination suit against her home-nursing company employer, Loving Care (great name, that) and exchanged e-mails with her attorney through a web-based personal Yahoo account that she accessed from a company-issued laptop. In the course of the discovery process the employer’s counsel imaged the laptop’s hard drive and found the e-mails, but did not promptly notify Ms. Stengart’s counsel and turn over the e-mails, as required by New Jersey’s attorney ethics rules. Although the employer purportedly maintained an Internet use policy that indicated “e-mail” and Internet use was the company’s property and could be monitored, the policy was poorly drafted and internally inconsistent, stating at the same time that occasional personal use of work computers was permitted.

The New Jersey Supreme Court held that, given the lack of clarity in the policy that appeared to invite some personal activity, and the fact that the policy did not refer specifically to employer monitoring of password-protected, web-based e-mail usage, Ms. Stengart had not been adequately placed on notice of her employer’s claimed right to monitor. Therefore, under the New Jersey constitutional and common law of privacy, she retained an objectively and subjectively reasonable expectation of privacy in her Yahoo account (i.e., that it fell outside the scope of the monitoring described in the Internet use policy), which Loving Care violated when its lawyers retrieved her private e-mails. Furthermore, the Court held — and this is the kicker — even if the employer’s policy had been totally clear that her Yahoo account usage could be monitored, it would not be enforceable to destroy Ms. Stengart’s attorney-client privilege in the e-mails with her lawyer.

The Court neatly summed up its views on Internet use policies at the end of the opinion:

“Our conclusion that Stengart had an expectation of privacy in e-mails with her lawyer does not mean that employers cannot monitor or regulate the use of workplace computers. Companies can adopt lawful policies relating to computer use to protect the assets, reputation, and productivity of a business and to ensure compliance with legitimate corporate policies. And employers can enforce such policies. They may discipline employees and, when appropriate, terminate them, for violating proper workplace rules that are not inconsistent with a clear mandate of public policy…. For example, an employee who spends long stretches of the workday getting personal, confidential legal advice from a private lawyer may be disciplined for violating a policy permitting only occasional personal use of the Internet. But employers have no need or basis to read the specific contents of personal, privileged, attorney-client communications in order to enforce corporate policy. Because of the important public policy concerns underlying the attorney-client privilege, even a more clearly written company manual — that is, a policy that banned all personal computer use and provided unambiguous notice that an employer could retrieve and read an employee’s attorney-client communications, if accessed on a personal, password-protected e-mail account using the company’s computer system — would not be enforceable.”

Until now, courts examining the issue of whether employees have privacy rights in personal online communications sent from work computers have largely deferred to employer Internet use policies that reserved broad monitoring rights. It is not particularly surprising that the New Jersey judiciary, with its more liberal policy preferences and insistence on the sanctity of the attorney-client privilege, has diverged from more employer-friendly, freedom-of-contract regimes like Pennsylvania in establishing limits on what employers can peek at with Internet use policies. Still, the Stengart case does provide some useful guidelines for how employers (in New Jersey and elsewhere) can structure their Internet use policies to avoid the loss of productivity and liability risks associated with uncontrolled employee web surfing, Facebook usage, etc., while at the same time avoiding a tort claim for invasion of privacy.

1. Specifically discuss whether and how employee access of password-protected, web-based e-mail accounts may be monitored. In other words, don’t make the mistake of the employer in Stengart and assume that references to “e-mail” usage will be interpreted to cover personal Yahoo and gmail accounts as well as messages sent via the company’s official e-mail system. So, for example, you should mention that e-mails from personal web accounts might be stored on the hard drive of the employer’s computer. Also consider giving similar examples with respect to personal activity on restricted areas of social media sites when accessed from work. Greater clarity and specificity about monitoring of password-protected account usage could also help prevent a Stored Communications Act violation as well as liability for invasion of privacy.

2. Don’t send mixed messages concerning personal Internet usage at work. The New Jersey Supreme Court indicated that an employer has the right to prohibit the use of work computers and Internet access for personal reasons and to discipline or terminate employees who violate this policy. For cultural reasons many employers have resisted taking such a draconian line up to now, but it may be time to consider drawing a line in the sand if productivity loss is a major concern. If an employer is willing to tolerate limited personal usage of company IT resources (subject to the restrictions in the policy and any blocking of particular sites that the employer considers a distraction), the policy needs to be absolutely clear that even allowed personal communications may still be monitored and stored. Bottom line for employers: tell your employees that if they consider something really private or sensitive, they should do it at home using their own computer.

3. Be consistent in applying the policy. This is a logical corollary of #2, i.e., don’t send mixed messages. Inconsistent application of an IT use policy landed the city of Ontario, California before the U.S. Supreme Court on April 19. In City of Ontario v. Quon, a SWAT team member was issued a department pager under a use policy that clearly indicated everything could be monitored. However, a supervisor allegedly assured Quon that personal text messages would not be reviewed as long as the employee paid for any overages. Needless to say, they were. The question before the Court is whether the supervisor’s statements, which deviated from the IT use policy, were enough to give Quon a reasonable expectation of privacy in the personal texts. Based on the transcript of the oral arguments, the justices seem skeptical (more so, perhaps, than the New Jersey Supreme Court might be). Their decision will be forthcoming in the next few weeks. However, the real take-away here is the case should never have happened. Make sure that all employees, including (and especially) managers confirm receipt of, and are knowledgeable about, your company’s Internet use policy (for example, it can be discussed in employee information security training). A well-drafted policy should describe the business interests underlying it and the company’s seriousness in promoting those interests, and should identify a contact person who can address any questions or issues concerning the policy. The company should also cultivate a culture of compliance (if you’ll forgive the alliteration) so that no one is perceived as exempt; selective application and enforcement can lead not only to privacy-related liability but discrimination claims too.

Now that employee privacy is more than just a rallying cry for plaintiffs’ lawyers, consider whether your Internet use policy could use a little loving care.

In Stengart, as I predicted in my last post on the case, the New Jersey Supreme Court held that an employee did not waive her attorney-client privilege in her suit against the employer by accessing her personal Yahoo! e-mail account through a work computer and using it to communicate with her attorney (not a good idea, but still …). On the other hand, in Quon, where the police department accessed and reviewed a SWAT team member’s provocative texts from a department-issued pager, the situation is a little murkier, and the Court seems leery of making a grand statement about workplace privacy.

What does all of this mean for businesses seeking to avoid liability and manage use of corporate IT resources? As I said, more on this shortly.

Readers of this blog know that the Bilski case will set the new standard for patent eligibility of business methods. In 2008 the U.S. Court of Appeals for the Federal Circuit upheld the Patent Office in setting a strict machine-or-transformation test that essentially bars the patenting of business methods except where they are tied to or transform something physical. If the Supreme Court agrees, this could invalidate a lot of Internet and software patents.

In the oral arguments several justices — most notably the newest one, Sonia Sotomayor — seemed uncomfortable with the intellectual contortions of the machine-or-transformation test, yet agreed that on some level a patentable invention must involve “technology.” But what is “technology”? How do you define it? A software patent whose claims delve into the nuts-and-bolts of the effects the programming has on the host computer probably teaches “technology”, but is it possible to drill down any further?

Here’s hoping (if not expecting) that SCOTUS brings some real clarity so that going forward clients will know when they are up to their elbows in “technology.” In the meantime, check out my recent articles (actually one article that my editor broke into two pieces because it was so verbose!) on the oral arguments in the Bilski case here and here.

More analysis soon. In the meantime, all you software and web startups should hold onto those patenting dollars unless your statutory one-year on-sale bar (i.e., the filing date for the patent must be no more than one year after the invention is first sold or otherwise commercialized or publicly disclosed) is about to expire.

Patenting Business Methods: The Floodgates Open – For a Time

Perhaps you’ve heard of In re Bilski, if not by name. At issue is the viability of business method patents, especially for processes that are implemented by computer or over electronic networks (namely the Internet). Most software and web patents are for business methods. After the U.S. Court of Appeals for the Federal Circuit confirmed in State Street Bank v. Signature Financial Group, 149 F.3d 1368 (1998) (involving a patent for a tax-avoidance method) that methods of doing business could be patent-eligible subject matter if they produced a “useful, concrete and tangible result,” a flood of business method patents were issued during the dot-com boom of the late 1990’s and early 2000’s. This period also saw a commensurate spike in cease-and-desist letters and “offers to license” from holders of business method patents, many of them “patent trolls” who had no interest in commercializing their inventions, but only in extracting license fees and infringement damages from companies with little inkling that apparently routine or ubiquitous methods and processes could be patented.

With incredulity and outrage mounting in the early years of the new century, the courts and the Patent Office began to eyeball business method patents more skeptically and moved to stem the tide. In 2001, the court hearing Amazon.com’s infringement suit against Barnesandnoble.com wound up invalidating Amazon’s “One Click” patent for a single user-action electronic fulfillment method on the ground that it was obvious in light of the prior art. The Patent Office has now instituted a procedure whereby patents for computer-implemented business methods are given an independent second review, resulting in far fewer business method patents being issued and a corresponding decrease in applications. Unlike copyrights and trademarks, a patent is extremely expensive to apply for, maintain and defend against invalidation, requiring tens of thousands of dollars in attorney and filing fees — and if litigation is involved, that amount is usually multiplied tenfold or twentyfold. A good friend of mine who is a patent attorney laments, “A lot of what I do is talk people out of applying for patents.” That may hurt the firm’s bottom line, but it is the right attitude from a client service standpoint, particularly now that the availability of business method patents may be severely curtailed.

Bilski: Patentability Requires a Machine or Transformation of an Article

Which brings us back to Bilski. In that case, the Patent Office refused to grant a patent for a method of hedging risk in commodities trading, not on obviousness grounds (which was the issue in the Amazon case), but rather because the application was not directed to patent-eligible subject matter. To be patentable under the statute (35 U.S.C. §101) an invention must be a “new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof.” Business method patents are “process” patents. The Federal Circuit, hearing the patent applicant’s appeal, agreed with the Patent Office that the application did not describe a patent-eligible “process”. In its en banc (full panel) opinion, reported at 545 F.3d 943 (2008), the court rewrote the legal standard for patentability of business methods, throwing the validity of more than a decade of business method patents into question.

Under the generally controlling legal test (referred to as the machine-or-transformation test), a process is only patentable if (1) it is tied to a particular machine or apparatus, or (2) it transforms a particular article into a different state or thing. (I call this the “generally controlling” test because the court speculated cryptically that some business methods could conceivably be patentable without satisfying the test, but did not care to elaborate.) The rationale for these limitations is that the patent statute was never intended to protect abstract principles, laws or phenomena of nature (even if just discovered) or mental processes, since, as the court put it, these are “the basic tools of scientific and technological work.” In the court’s view, requiring the limitation of process patent claims to a specific machine or the transformation of some specific matter safeguards against a patent owner pre-empting all uses of a fundamental principle that everyone ought to have resort to in the furtherance of progress.

The need to prevent any patent owner from pre-empting all uses of a principle leads to some further caveats. First, if a principle can only be implemented using a particular machine, limiting the patent claims to that machine will not turn the principle into a patent-eligible process. So, far example, in Gottschalk v. Benson, 409 U.S. 63 (1972), discussed extensively in Bilski, the Supreme Court held that a numerical algorithm for converting binary-coded decimal numerals into pure binary numerals was not a patentable process even when limited to a digital computer, since the algorithm will always be implemented on a computer. (This concept obviously has great significance for the validity of many software and Internet business method patents.) Secondly, limiting the patent claims to a single field of use also will not make a patent-eligible process. As the Bilski court noted, if the opposite were true, then one could patent the Pythagorean theorem as used in surveying. Finally, “insignificant” pre- or post-solution activity, such as data gathering or recording a result, which may involve some peripheral use of a machine or a transformation of matter, does render a principle patentable. Of course, what activity is “insignificant” is less than clear and will be the subject of much future patent litigation.

Applying the machine-or-transformation standard with these caveats, the Federal Court affirmed the Patent Office’s denial of the patent claims for the risk hedging method. It also eviscerated (without formally overruling) its ruling in State Street by holding that the “useful, concrete and tangible result” standard is no longer valid. At the same time, it rejected the proposition that business methods are never patent-eligible subject matter. Since the patent statute allows a patent to be issued for a “process,” a business method is patentable subject matter if it is tied to a particular machine or transforms an article into a different state or thing.

If the Supreme Court affirms the Federal Circuit’s reasoning, most business methods implemented through software or Internet will no longer be patentable. As discussed by the Federal Circuit in Bilski, the Supreme Court, in Diamond v. Diehr, 450 U.S. 175 (1981), held that a software algorithm can be used to control the execution of a physical process (curing rubber) which is patentable when considered in its totality, i.e., including the software component. Likewise, the court noted that manipulation of electronic signals or data can form a patent-eligible process (on the basis of a transformation of matter) if the signals or data are not abstract but represent tangible physical objects (e.g., X-ray data that is manipulated to produce images of bodily organs). However, the business method in Bilski involved, at most, the transformation of risks and liabilities, which as intellectual abstractions are not eligible “articles.”

Should I Patent?

What do all of these arcane patent rules mean for technology clients? One the one hand, investors see patents as valuable assets, and so they are – if they are actually issued and the claims are broad enough so that a competitor can’t easily maneuver itself outside their reach. A “patent pending” notice also lends gravitas to one’s website and marketing materials (you can use this notice just by filing a provisional patent application, by the way). However, rejected patents and narrow patents do very little good for anyone, except the lawyers, of course.

Whatever the Supreme Court ruling in the Bilski case (and I expect an affirmation of the Federal Circuit’s approach at least in part), the change in the legal landscape will be largely limited to process patents and to business method patents in particular. Someone looking to obtain a patent in a composition of matter, a machine or a manufacturing process should not stop the patent train to await the Court’s ruling; while some general concepts in Bilski, namely the unpatentability of natural phenomena, mathematical formulas, etc., are applicable to all types of patents, as a practical matter, unless you’re trying to patent some naturally occurring compound, for example, the case doesn’t have much relevance if your invention is not a business method. On the other hand, I would strongly advise clients desiring protection in pure software or Internet processes to file a provisional patent application at most (which is cheap) but hold off any non-provisional patent application for a few more months. (You can file a patent application up to one year after the invention is first publicly sold or used or disclosed in non-confidential fashion.)

Consider Trade Secret Protection for Software and Other Business Methods

Moreover, unavailability of patent protection, or of broad patent protection, does not mean the total absence of intellectual property protection. Clients and counsel evaluating IP protection strategies for a new invention often overlook the need to balance the costs and benefits of patent protection against those of trade secret protection. (Software is also protectible by copyright.)

Patent protection is, by definition, a grant of exclusivity in a limited set of claims for a limited period of time (20 years) in exchange for disclosing a new, useful and non-obvious invention into the public domain. Patent applications become public after 18 months (whether or not a patent is actually issued) unless the applicant disclaims foreign patent protection. If no patent is issued or protection is granted in only a narrow set of claims, the applicant has obtained little or no competitive advantage for its money, and now the secret is out. On the other hand, by instituting procedures to treat a proprietary process or business method as a trade secret, such as internal access restrictions, limitation of external disclosures, use of confidentiality agreements, confidential or proprietary legends on material relating to the process or method, and logging who has contact with it, a company can preserve legal rights against usurpers for a theoretically indefinite period of time. Trade secret protection requires no legal fees and no filing fees. (Copyright protection requires nominal legal and filing fees.) If the Supreme Court embraces the Federal Circuit’s reasoning in Bilski, trade secret (and copyright) protection should supplant patent protection as the optimal strategy for many software and web clients.

As always, stay tuned. Oral arguments before the Supreme Court have been scheduled for November 9. You can expect to find updates on those arguments, as well as an analysis of the Supreme Court’s opinion and what it means for your business, on this blog as events unfold.