Out of Balance

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In a sense, the patent system is a victim of its own success. As intellectual property moved from the periphery to a central role in both corporations and the greater economy over recent decades, it attracted increasing attention and capital. But big growth inevitably leads to new problems.

From mounting pendency and quality problems at the overwhelmed U.S. Patent and Trademark Office (PTO) to a proliferation of predatory, even parasitic, litigants to cases that call into question core tenets of patent law itself, today's IP system frankly seems a bit out of whack.

"If you just think of IP as an ecosystem, these problems are all just different parts of it," says Lisa McFall, managing director of the IP consulting firm Ovidian Group. "One part will affect the other parts, eventually. If one part simmers down, then the rest can come back into balance, but they're all interrelated."

Add a deep recession to the mix, and the troubled ecosystem starts to look like a jungle. This month, InsideCounsel looks at five of the most pressing questions affecting in-house patent practice. None are discrete--each is connected to at least some of the others. But all need to be answered to get the system back in balance.

Can David Kappos save the PTO?

The patent office is a mess. Complaints about how long it takes to get a patent and the quality of examination are nothing new, but in the past few years these perennial problems have gotten a lot worse.

First-action pendency is up 88 percent since 2000. Total action pendency passed 32 months in 2008, up from 25 months at the beginning of the decade, and nearly double the office's target of 18 months. The backlog is exacerbated by a drop in first-time filings since the economy tanked, meaning the PTO has to dig out of a deep hole with shrinking resources. (Filing fees account for more than a quarter of the agency's budget.) In fact, the office faces a $200 million shortfall in 2010.

In total, more than 1.2 million applications are waiting for approval--or rather, with increasing frequency, rejection.

"I've actually had several former examiners tell me that they take the path of least resistance," says Tom Miller, who heads the IP practice at Michael Best & Friedrich. "Oddly enough, the path of least resistance is to reject applications time and time again."

On the other hand, critics complain that many of the patents the PTO eventually grants are of poor quality. That's a recipe for long, expensive litigation because courts and juries can be loath to challenge validity.

"There are district courts where it's very difficult to get any sort of summary determination that the patent is invalid," says McFall, who previously was head of IP litigation at Yahoo. "You usually have to wait until you get to trial and a lot of juries just don't like to overturn patents."

The problems are not entirely of the PTO's making. Examiners complain of frivolous applications with dubious prior art that sap time and attention from legitimate claims. Moreover, for a dozen years starting in the early 1990s, the federal government effectively plundered revenues generated by patent applications for unrelated projects, starving the office of resources it needed to meet growing demand.

Onto this troubled stage comes David Kappos--formerly assistant general counsel for intellectual property at IBM--who was confirmed as PTO director in August. The hire was widely heralded in the IP bar, particularly among in-house practitioners.

"I'm very pleased that they selected David Kappos. He brings the right kind of background and experience to bear," says Jim Trussell, associate general counsel and chief intellectual property counsel at BP. "I'm very confident that if anybody can have a significant impact, it's David."

Kappos immediately launched an ambitious plan to reform the PTO. At the same time, he also acknowledged that things will get worse before they get better. Because of the budget shortfall, the agency will actually shrink in 2010, and as a result, the backlog won't.

"Let me say right up front, we need your help," Kappos told the Intellectual Property Owners Association (IPO) annual meeting in September. "We need your support, we need your input, we need your advocacy, and we need your patience. In exchange, we will be completely transparent--sharing with you the good, the bad and the ugly of what's happening at the USPTO."

How will Bilski resolve?

The Supreme Court granted cert in June for In re Bilski. The appeal of the Federal Circuit's controversial en banc ruling adds yet another chapter to the dozen-year dispute. In the balance hangs the scope of an entire class of patents.

Courts have wrestled for years with the patentability threshold for process applications, conceptually the slipperiest patent category. In its ruling, the Federal Circuit relied exclusively on the so-called machine or transformation test, which holds that a process must reduce or transform an article to a different state or thing, or be tied to some sort of machine. The Bilski patent, a method of commodities hedging, met neither side of that test.

"That set off alarm bells across the country; that's a pretty restrictive test," says Bob Laurenson, an IP partner at Howrey. "That cuts out a lot of processes people thought would be patentable. Not just business methods but other processes as well."

Some medical diagnostics and wireless signal manipulation technologies, to cite a few, would not clear such a strict process patent threshold. Widespread concern led scores to file or collaborate on amicus briefs.

"In our view, the Bilski decision may be a first step toward defeating patentability of software and services, which is not in the interest of companies in that business," says Mary Doyle, general counsel of Palm Inc., which is among the Bilski amici. "From the perspective of some, it may be the first step in weakening the patent system altogether."

There are two central questions at stake in the Supreme Court appeal. The first is whether the specific commodities trading claims in question are patent-eligible. On that point it appears likely the high court will affirm the Federal Circuit ruling. At no stage, from the initial 1997 application onward, has any court or the patent office held Bilski's claim patentworthy.

The second question, however, is the one with watershed potential: What test should be applied to process patent applications?

Laurenson hopes for a two-tiered test. If an application passes the machine and transformation test, it's in--it may be considered for a patent. But if it fails, it would be subjected to a second, "pre-emption" test, which asks whether the patent would pre-empt a fundamental principle, such as an abstract idea, a natural phenomenon or a law of nature. If not, it clears the threshold for review.

"A lot of the amici support a view in which the machine or transformation test is just one of many that could be applied," he says. "I think the Supreme Court is going to look at the Bilski claims and say, 'That is pre-empting a fundamental principle, the abstract idea of hedging. That should be out there for everybody to use.'"

Is the litigation model changing?

The trolls--or nonpracticing entities (NPE), as they are more civilly called these days--are getting worse. Even as company-to-company litigation has ebbed in the recession, litigation by plaintiffs who assert patents as their business model continues to rise. According to RPX Corp., a company that aggregates patents for defensive purposes, NPE cases are up 25 percent in the past year alone. Litigators corroborate the trend anecdotally.

"Of my patent cases, if I tallied them up right now, all save two are classic, nonpracticing entity defense cases," says Michael Jacobs, co-chair of the IP group at Morrison & Foerster.

For NPEs it's a volume business--the more people you sue, the more you make. They bank on the simple fact that some defendants will just pay them to go away.

Some companies, however, have had enough and are banding together to fight NPEs en masse, and at a reduced cost.

"There is value in joint defense, where the circumstances and the parties are aligned in their interests," BP's Trussell says. "A big part of the nonpracticing entity leverage is low cost on their part--no real counter claims, no real discovery burden. It's disproportionately expensive for defendants. A dozen defendants could each afford a share of litigation to the extent that one of them couldn't. It will make it easier for defendants to come in and fight on the merits instead of just settling for a palatable fraction of what their defense costs would have been."

The logic is simple: Working together reduces cost and levels the playing field. But joint defense is no panacea.

One obstacle is conflicts. With each additional member in the group, it gets progressively harder for the law firm to clear conflicts or get waivers. As a result, sometimes the lead firm is not anyone's first choice.

"The other side of the coin is a kind of anti-conflict issue," Jacobs says. "If you're too close to one of the defendants, the other defendants may get nervous."

Some companies also grow frustrated with the inefficiency of group defense. The more cooks in the kitchen, the harder it is to reach consensus. A lot of legal fees are burned getting everybody on the same page. The key to effectiveness, experts say, is how carefully the group is organized.

"Obviously, when all of the defendants are similarly situated in terms of accused products and business models, it's easier to coordinate and have one voice speaking on issues," says Elizabeth Day, a partner at DLA Piper. "When you have companies with different products, it's difficult to get everybody to agree."

How do you do more with less?

"I've been feeling the pain of my clients," says Day, of DLA Piper. "I'm constantly receiving e-mails from clients saying, 'This quarter's going to be tight, you need to come in under budget, and I have two dollars for you to spend this month!' It makes it a little more interesting when you've already spent those two dollars. You have to adjust and work with your clients."

There's plenty of pain to go around. The pressure is on law departments to cut spending, and intellectual property is no exception. Companies are revisiting every aspect of their IP function, and finding creative ways to cut back.

"Most of the questions these days are driven by the economy," says BP's Trussell. "You have to imagine every in-house department is under some cost pressure, whatever they are doing."

Outsourcing, insourcing, alternative fee arrangements, even trimming the portfolio itself--no options are off limits.

"We're looking at things like using retirees on a contract basis, or using lower cost associates on an in-placement basis--they sit in our office, but we pay a discounted hourly rate for buying in bulk," Trussell says. "We're also looking to lower-cost law firms than the traditional New York or D.C. law firms."

Companies are also being more selective about what they choose to patent and more attentive to the prosecution process itself.

"A lot more pressure is being placed on outside counsel to be efficient," says Doug Luftman, chief IP counsel at Palm. "So rather than every patent application being a one-off, attorneys are starting to reuse work they have done before for that client and being more creative in pushing work down to less expensive associates."

In at least one way, a more selective prosecution strategy helps the big picture. An 'if in doubt, file for a patent' mentality is one of the factors behind the PTO's mammoth backlog. More prudent patent applications save the company money and help alleviate the pendency problem.

Is the Federal Circuit up to snuff?

One subtext of the Bilski case is that it's the latest in a string of major patent cases to be successfully appealed to the Supreme Court in recent years. In KSR (2007), eBay (2006) and Festo (2002) the high court overruled the Federal Circuit on such cornerstone subjects as obviousness and the doctrine of equivalents.

It begs the question: Why is the nation's dedicated intellectual property court missing the mark?

"There has been some arrogance at the Federal Circuit, where they feel they have unique expertise on how the patent law should apply," says one patent lawyer, who requested anonymity. "In some sense, Federal Circuit decisions have ignored Supreme Court law. I don't think the Supreme Court was all that aware of it for a while, but with Festo and KSR people started petitioning to make them aware that their precedents were being ignored. That led to a situation where the Supreme Court is monitoring the Federal Circuit more closely."

That short leash may have led the Federal Circuit to be gunshy in the Bilski case, where an overly solicitous opinion resulted in the exact situation it was designed to prevent: another successful Supreme Court appeal.

One thing that hampers the Federal Circuit is the rule that governs its composition, practitioners say. Under the Baldwin Rule, which dates back to the Federal Circuit's origin, judges must reside within 50 miles of the bench, in the District of Columbia. That, critics say, limits the court to Beltway lawyers who may be out of touch with the issues IP owners face on the ground across the country.

"There should be an increased focus on recruiting experienced patent practitioners to the Federal Circuit bench," says Palm's Doyle. "Our view is that there are a lot of very experienced patent litigators and other practitioners that come from other jurisdictions, not to mention the in-house community, that have an exposure to issues that might give the Federal Circuit a broader view of the challenges confronting litigants across the country."

Contributing Author

Steven Andersen

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