The Supreme Court has a chance to give innovation a boost this year by rolling back one of the country's most economically stupid policies. With the case of Alice Corporation v. CLS Bank International, the justices will dive into the issue of whether companies should be able to patent computer software.
Here's the background. The Alice Corporation claims that CLS Banking International is violating its general patent that claims to implement an escrow function between traders in financial derivatives. To be clear: CLS Banking was not using software developed by Alice Corporation. Escrow entails a third party holding a financial instrument—say, securities or funds—on behalf of the other two parties in a transaction. The funds are transferred once the parties have fulfilled their obligations. The practice of escrow goes back at least as far as the Middle Ages.
Now, the purpose of patents, in Abraham Lincoln's words, is to offer an incentive for "the discovery and production of new and useful things." They also constitute a disclosure mechanism in which inventors are awarded exclusive use of their inventions for 20 years in exchange for clearly revealing to the rest of us how they are made, thus avoiding a world pervaded with trade secrets. According to Section 101 of the U.S. Patent Act, patents may not be awarded if the claimed invention "would have been obvious" to anyone "having ordinary skill" in the relevant art.
The upshot is that Alice Corporation says it deserves a patent because it was novel and non-obvious for them to suggest using computers to facilitate the ancient legal process of escrow.
This isn't even the most egregious recent case in this field. In Ultramercial v. Hulu, Ultramercial claimed to have exclusive rights to the idea of trading advertisement viewing for access to content. The patent does not specify any actual software code, just the concept the code is executing. In other words, Ultramercial says no one had ever before thought to oblige people to see or hear commercials in exchange for access to copyrighted material. No one except purveyors of, say, television, newspapers, and radio. Astonishingly, in June 2013, the Federal Circuit Court of Appeals ruled the Ultramercial patent valid, essentially because the company specified that the advertising would be viewed over the Internet. Some critics of software like the Electronic Frontier Foundation would have preferred that the Supreme Court take this case instead of Alice v. CLS.
Cases like these would be a ridiculous legal sideshow were it not for the proliferation of software patent infringement lawsuits, and lawsuit threats, by patent trolls. Patent trolls—the technical term for them is "non-practicing entities," or NPEs—basically buy up lots of dodgy patents and wait for someone to allegedly infringe. At that point, the troll's lawyers send out a letter demanding royalties.
Some patent trolls are no longer just going after tech manufacturers and vendors; they are now threatening litigation against innocent users of some products. For example, in 2011 Innovatio IP Ventures claimed that hotels, coffee shops, and restaurants that offer WiFi to their customers are violating its patents. They demanded a licensing payment of between $2,300 and $5,000 from each business location. Patent defense costs a lot of money, so many small companies simply cave and hand over the cash to the extortionists.
A 2010 Georgetown Law Journal study looked into recent patent litigation history and found that "NPEs and software patentees overwhelmingly lose their cases, even with patents that they litigate again and again." In fact, NPEs won only about 9 percent of the time. This strongly suggests that their patents are pretty low quality. In 2012, NPEs brought 61 percent of all patent litigations, up from just 5 percent 10 years earlier.
This isn't just a recipe for individual injustices. The rising flood of dubious software patent infringement litigation is significantly retarding innovation and wealth creation. In a 2010 article for Regulation, the Boston University legal scholars James Bessen, Jennifer Ford, and Michael Meurer found that NPE lawsuits and infringement threats "are associated with half a trillion dollars of lost wealth to defendants from 1990 through 2010." The wealth lost in each of the prior four years had amounted to $80 billion annually. In a 2012 working paper, Bessen and Meurer calculated that the direct costs of litigating or paying off NPE patent claims amounted to $29 billion in 2011. This figure excludes other costs to innovation, such as the diversion of resources, delays in new products, and loss of market share.
Speaking of the diversion of resources: Microsoft, Google, Apple, Samsung, and other tech giants have amassed software patents not because the companies expect them to fuel their innovations, but because they need them to defend against one another. For example, a consortium including Microsoft and Apple banded together to buy the patent portfolio of the bankrupt Canadian telecomm equipment manufacturer Nortel for $4.5 billion in 2011. Analogizing the legal situation to the Cold War's mutually assured destruction, a venture capital cliché runs: "Patents are like nuclear bombs, you just got to have some."
The Supreme Court has long held that the laws of nature, natural phenomena, and abstract ideas are not patentable. Merely adding "on a computer" or "over the Internet" to otherwise conventional processes like selling merchandise or sliding to unlock a cell phone should not be patentable. The Supreme Court would go a long way toward fixing the current software patent chaos if it limits patents to inventions that actually involve some mechanical process or the creation of novel physical products.
In the meantime, Congress may offer some relief: The Virginia Republican Bob Goodlatte has introduced the Innovation Act. This would not end software patents altogether, but it would narrow the grounds for software infringement lawsuits, prevent suits against innocent users of technology, and force the losing party in such suits to pay litigation costs. The bill passed on a vote of 325 to 91 in the House last week and is expected to pass in the Senate.
But the Supreme Court has the power to go farther. At an earlier stage of Alice v. CLS' litigation, Judge Kimberly Moore of the Federal Circuit Court of Appeals wrote that "if all of these claims, including the system claims, are not patent-eligible, this case is the death of hundreds of thousands of patents, including all business method, financial system, and software patents." If so, good riddance.
Related video: "How Patent Trolls Kill Innovation," produced by Zach Weissmueller. For more info go here.