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Surviving the Patent Shakeup

In 2004, casino gaming systems company Bally Technologies found itself being sued by a competitor named Shuffle Master, as well as International Game Technology, a giant in its industry. Bally had been trying to expand into the casino data management market, and both plaintiffs were trying to keep it out.  Then came last year’s KSR …

In 2004, casino gaming systems company Bally Technologies found itself being sued by a competitor named Shuffle Master, as well as International Game Technology, a giant in its industry. Bally had been trying to expand into the casino data management market, and both plaintiffs were trying to keep it out.  Then came last year’s KSR v. Tele-flex Inc. Supreme Court decision, which halted literally decades of patent practice by tightening how “original” an invention had to be to gain a patent. Bally got a summary judgment invalidating one patent and dismissing the claim of infringement of the other patent.

“In our particular case, we are not now feeling too at risk based on the patent portfolio we have and how we developed that portfolio,” says Richard Haddrill, Bally Technologies’ CEO. “But I think there are products in our industry and others that generate significant economic value that could be at risk.”

The normally staid patent world has been roiling of late with Supreme Court decisions, attempts to significantly alter the way patents are processed and evaluated, and even major proposed legislative changes to the entire patent system. Taken together, these could literally remake the entire patent process. Entire industry competitive landscapes could shift, affecting the value of products and even corporations. What seems to be the stuff of legal journals might play out in the boardroom of virtually every corporation. CEOs who push the issue off on lawyers risk seeing their companies’ futures come up all lemons in a high-stakes game. 

IP Affects Strategy

Patents aren’t a legal tool applied tactically. Rather, they represent an intrinsic part of a company’s value to investors. “In the technology and the life sciences sectors, the intellectual property and patent portfolio is a huge driver of valuation,” says Betsy Atkins, a board director at such companies as the NASDAQ Stock Exchange, Chico’s, Reynolds American, Polycom and SunPower. “A key way that public companies and private equity firms value acquisitions is based on their intellectual property and patent portfolios.”

Even when the industry is more mundane, patents tie in to product strategies and corporate value. According to Matthew Rinaldi, president and CEO of Arquest, Inc., a Johnson & Johnson spin-off and the second largest North American producer of store-brand diapers, his industry sees dozens of new patents a month, with thousands previously granted that can affect whether a company can release a new product. “It’s one of the most technologically over-engineered products ever created,” he says. “It’s a patent minefield.” Picking a path requires building collaborative relationships with competitors and working with product development to avoid conflict whenever possible.

In other words, a basic part of competitive strategy is protecting intellectual assets. John Cronin, managing director and chairman of intellectual property consultancy ipCapital Group, says that IP protection “provides 25 percent of product sales value.” The right IP protection for a product or service can boost sales margins by 20 percent. “In some fields, like drugs, the difference between having some patent protection or none is [total],” he says.

When something goes wrong with a key patent, stock prices can take a big tumble. Forgent Networks held a key patent in the digital photo area. The day the U.S. Patent and Trademark Office (USPTO) agreed to reexamine the validity of the patent based on a request filed by a nonprofit, the company’s stock price dropped 40 percent.

Companies have approached product and service development and exploitation literally based on hundreds of years of precedent and decades of experience with patent rules and regulations. With this much stability, why are there attempts to change the system? Because the patent process has run amok. An ever-growing application backlog delays many patent grants by years, which weakens protection for products and technology and slows market entry.

Over the last few years, various forces have pushed for change in how companies can apply for patents and in the nature of what can be patented. Depending on the particulars of industry dynamic and previous corporate strategy, any one  of these changes could send shockwaves through business. “It clearly affects corporate strategy,” says Bill George, a director on the boards of Exxon Mobil, Goldman Sachs and Novartis. 

Sea Changes

So many changes are in the works that the world of patent protection could heave, prompting a corresponding upheaval for businesses. Take some USPTO-proposed changes in rules governing continuances and claims, for example. The first term refers to the longstanding ability to start a patent in the U.S. and then amend it over time; the latter refers to an invention’s properties that make it unique and worthy of protection.

Overwhelmed by pending applications, the USPTO wants to reduce as much as possible the work its examiners must do by generally limiting continuations to two and total claims to 25. But a number of interested parties, including GlaxoSmithKline, have sued. (The Patent Office plans to appeal a district court decision that favored the plaintiffs.)

Pharmaceutical and biotech companies hated the proposal because they are the most dependent of any industry on continuations and large sets of claims. “A lot of biotech and pharmaceutical inventions are so complex, they could involve a whole family of molecules,” says Chris Holman, associate professor at the University of Missouri-Kansas City school of law. Each of those families could include hundreds of members. Unfortunately, “[the companies] don’t know exactly which molecule is going to be in the final commercial product, what form it will take, what methods will be used to make it.”

The companies want surety and protection. Under the existing virtually unlimited claims lists and continuations, companies have been able to acquire protection while continuing their research. The proposed limitations would put them into a quandary: If they hold off on patent applications to better understand what to patent, they risk a competitor locking up a new development. “

You have companies filing hundreds or thousands of applications a year,” says Jeff Oelke, a partner in the IP practice of White & Case. “If limits prevail, it will affect their choices of which to file and when.”  

Uneven Fallout

From a corporate perspective, what makes the proposed changes so difficult is that they harm some companies and benefit others- sometimes even in the same industry. For each GlaxoSmithKline, there is a company that would find fewer applications and patents a boon. “There’s been rising concern among lots of folks that patents have become too easy to get, available in too many areas, and that the increase in the availability of patents may actually be retarding technological innovation and growth, and actually hurting industries,” says Gregory Mandel, professor of technology and intellectual property law at Temple University’s Beasley School of Law.

Consumer electronics is a prime example. “The cell phone I’m talking into is a Windows mobile email- capable device,” says Ron Epstein, CEO of intellectual consultancy IPotential. “There are probably 15,000 applicable patents [involved in its construction].” Making deals to clear development in an industry with a product life cycle that is only six months long is difficult. That’s why a number of large companies in the high-tech space have lobbied for making patents more difficult to obtain and seriously reducing the potential damages a patent holder could claim for an infringement when the patent governs only a minor aspect of the infringing product.

“You cannot ignore it,” says John McNulty, CEO of enterprise security company Secure Computing. “Any time we embark on a new piece of technology, we try to be aware of any patents that are out there, and do searches for things that we should be aware of.”  

Congressional Call

Legislative changes could have their own impact on many industries. One proposed alteration to the Patent Reform Act of 2007, according to Bruce Lehman, senior counsel with Akin Gump Strauss Hauer & Feld and a director of the USPTO under Bill Clinton, would allow practically unlimited post-grant opposition, meaning faster issuance of patents, but continued risk of challenge “on a fast track basis” using a lower legal standard than is necessary in court.

The bills might move U.S. patents from a first-to-invent approach, which recognizes the actual first inventor, to first-to-file, like the rest of the world. The existing difference has given corporations some flexibility in when they file, so long as they could prove the date of an invention. But under first-to-file in the U.S., companies will have to rush to protect their work.

 “The patent system is a tradeoff,” says White and Case’s Jeff Oelke. “You’re supposed to be disclosing knowledge to the public while excluding others from the area. You need enough information in the application to show how to make [the invention] and how to use it. The earlier you file a patent application, the less information you’ll have to meet that requirement,” possibly weakening the patent.

According to Cronin, all the potential changes affect board level strategy. “Will we get the same number of patents?” he asks. “The answer is no. Will we get better quality patents? The answer is no.” Patents may actually be worth less on the open market, changing the value of the company’s holdings. Smaller companies that might be acquisition targets might suddenly become more or less valuable, with the change in their patent positions. “The changes in the patent system by most accounts are very drastic,” Cronin says, and most observers agree that some amount of alteration will occur. Boards must study the final changes and ensure that management is adopting the tools and processes that will let their corporations adapt.

Those steps should start with an evaluation of the company’s patent portfolio, as well as those of major competitors. From there, IP experts should be able to identify each one’s values and strategies, note their strengths and weaknesses and consider IP protection directions that could enhance the company’s position. All these considerations are material. Left unaddressed, they could cause significant problems for a corporation, even raising Sarbanes-Oxley questions.

“The whole premise is that the board members are doing the right things for the assets,” says Cronin. 

Unintended Consequences

If there is a change, there are likely also to be unintended consequences. Because of some nitpicking details, Epstein thinks that the continuation rule could be painful to everyone. “The patent office was, in good faith, trying to ease their internal problems,” he says. “The rules require you to jump through more hoops, state more things, do more research, file more paperwork, all under the rubric of improving patent quality, greatly increasing the cost of a patent. Even if you have a very good idea of what you want to patent initially, the Patent Office is more likely to grant you a narrower patent rather than a broader patent.” Things aren’t necessarily any better on the congressional front. “I know generally what Congress is trying to do, but this area is so complex that it’s pretty clear that Congress has no idea what the results of the [Patent Reform Act of 2007] will be,” says Robert N. Yerman, senior managing director, head of the IP practice, at LECG. “They think they’re mandating or directing certain results, but oftentimes what you legislate doesn’t necessarily follow. You’ve got big companies on both sides saying the act is good, the act is bad, and it all depends where you sit and how it works out.” If you’re in a small to mid-sized company, the hard and soft cost increases could make being competitive and getting ahead even harder than it is today. “One of the things [the changes would do] is increase the importance of an IP legal office, because they have to move extremely fast,” says George T. Haley, director of the Center for International Industry Competitiveness. “You have many companies researching virtually the same thing, and then it becomes a race of who can do the research and get it completed as soon as possible, and then race to the patent office.” The current bills on the Hill seem to be comatose at the moment, but that should offer little comfort. According to Mandel, a push for legislative patent reform started in 2005, and even though the bills have been scaled down in each year, there is no telling what might pass in the next few years. And then there are the courts. “The last five Supreme Court cases in the last two years-if you look at things as stronger patent rights versus weaker patent rights-they’ve all come down on weaker patent rights,” he says.

In short, the patent wars and waves are going to upset a lot of business stomachs in many companies, and the only solution might be a solid dose of strategic patent medicine.

About erik sherman