Should a service provider develop a patent portfolio?  In performing outsourced services, the service provider performs certain business processes that range from information technology to office procedures.  Since U.S. courts have interpreted patent laws to make business processes eligible for patent protection, the patent law has played a small but growing role in business process outsourcing.   This article addresses some key issues in patent law in outsourcing, including validity, infringement, extraterritoriality and the role of patents in outsourcing.

What is a Patent?

A patent is a statutory monopoly that allows the inventor to practice an invention, to allow others to use the invention under terms and conditions that the inventor considers acceptable and to prevent unlicensed persons from using the invention.   Under U.S. law, an invention must be novel, useful and non-obvious to one skilled in the existing “art” (science).   It is the specific claims in the specification of the invention that are entitled to the statutory monopoly.  In patent applications, claims are written as independent (and therefore unrelated to any other claim) or dependent (and therefore viable only if the related independent claim is valid).

Impact on Competition.
Quite simply, patents stifle competition.  For this reason, courts and regulators have adopted limitations on abuses of patents, such as tying the use of non-patented goods or services to patented goods or processes.

The Specification.
The patent application must set forth the “specification” that describes the exact scope of an invention and its method of “manufacture” in sufficient detail that it describes what  is left to the public outside the scope.   Markman v. Westview Instruments, Inc., 116 S. Ct. 1384, 517 U.S. 370, 373 (1996).   The specification consists of two parts:

• a detailed “written description of the invention and of the manner and process of making and using it, in such full, clear and concise, and exact terms as to enable any person skilled in the art … to make and use the same.”   35 U.S.C. 112, para. 1.
• a conclusion “with one or more claims particularly pointing out and distinctly claiming the subject matter which the applicant regards as his invention.”  35 U.S.C. 112, para. 2.

General Definition of Patentable Processes.
Patentable process “inventions” must involve a “process, art or method, and include… a new use of a known process, machine, manufacture, composition of matter, or material.”  35 USC 100(b).   “Whoever invents or discovers any new and useful process, machine, manufacture or composition of matter, or any new and useful improvement thereof, may obtain a patent therefore,” subject to the patent law’s other provisions.  35 U.S.C. 101.

Software Patents.
Software patents have been issued in the United States since 1982, when Merrill Lynch patented a financial transaction software application that links securities brokerage accounts with” cash management accounts.”  U.S. Patent No. 4,346,442.  While early judicial decisions quibbled that the processing of data was not an eligible process, the courts and the U.S. Patent and Trademark Office have generally accepted the patentability of software.

Business Process Patents.
Business methods are the sequence of steps that are undertaken to engaged in a specific business activity.  Until 1998, a business method was considered to be an idea, and business methods as ideas were not patentable.  In July, 1998, the U.S. Court of Appeals for the Federal Circuit did away with that interpretation of the U.S. patent law. The case, State Street v. Signature Financial, legitimized the patentability of software that Signature had written to enable it to administer mutual funds more efficiently. The software merely embodied a business process.   The court’s language was broad enough to embrace any business process (as long as it was new and “nonobvious” and had a “useful, concrete, and tangible result”).  Congress has done nothing to restrict this judicial interpretation.

Validity.

Once issued by the U.S. Patent and Trademark Office, a patent is presumed valid.   35 U.S.C. 282.   The party who seeks to invalidate a patent or any individual claims has the burden of establishing invalidity.  To meet this burden of proof, the party seeking to invalidate must prove the invalidity by “clear and convincing evidence,” a standard that is very high.  Helifix Ltd. v. Blok-Lok Ltd., 208 F.3d 1339, 1346 (Fed. Cir. 2000).   In making its proof, the party seeking to invalidate may rely upon a variety of arguments.   Such arguments may include an assertion that the patent holder engaged in “fraud on the patent office” by failing to disclose relevant “prior art” that would have prevented the issuance of the patent in the first place.

In litigation seeking to invalidate a patent, the first issue is one to be decided by the judge: what is the scope of the claims in the patent?  The second issue is one for the jury: has infringement occurred?   Markman v. Westview Instruments, Inc., 116 S. Ct. 1384, 517 U.S. 370, 384-391 (1996).

Enforcement of Patent Rights.

Enforcement of patent rights presents problems both for the patent holder and for the alleged infringer.  The patent holder risks invalidation of the patent, thereby losing the right to claim royalties from all licensees.  The alleged infringer (who may include an unhappy licensee unwilling to pay future royalties) may risk heavy damages.

Doctrine of Equivalents.
Judicial interpretation of patent claims adopt two approaches: literal and interpretive. Under historical case law, the monopoly of a patent claim extents beyond the literal description and covers “equivalents” as well.  Applying some judicial discretion in the interpretation of the literal scope, the doctrine thus allows an infringement claim where the differences between the accused device or process and the patent claim are “insubstantial” and represent only “trivial changes.”

Prosecution History Estoppel.
Affirming this principle, the U.S. Supreme Court has restricted it by noting that the patent applicant’s modifications to its application forms a “prosecution history” that can serve as estoppel for any purpose under the patent law, not merely relating to eligibility (by narrowing it to deal with prior art).   Festo Corp. v. Shoketsu Kinzogo Kogyo Kabushiki Co., Ltd., 535 U.S.722 (2002).   At common law, the equitable principle of estoppel serves as an enforceable bar to assertion of a right or claim of right.  The Festo decision permits alleged infringers to review the file history and rely upon any concessions or limitations made by the patent applicant as a basis for limiting the scope of the patent claims.  Prosecution history estoppel under Festo thus opens the flood gates for competition who read the file history and look for concessions made by the applicant.

In Honeywell Int’l Inc. v. Hamilton Sundstrand Corp., 2004 WL 1202997 (Fed. Cir. June 2, 2004), the Court of Appeals for the Federal Circuit ruled that, in the patent prosecution process, the applicant is deemed to have waived the full breadth of a broad independent claim when it re-writes the claim to be more specific.   Historically, patent prosecution involves the normal process of writing a “stand-alone” (independent) claim followed by a subsequent dependent claim (relying on the “stand-alone” claim’s basic premise).   When the patent examiner rejects the stand-alone claim and asks the applicant to rewrite it to convert the dependent claim into a new stand-alone claim, the applicant may do so.  In doing so, the applicant is deemed to abandon the full scope of the original stand-alone claim, and to rely only on the dependent claim.

Under the Festo decision as interpreted in Honeywell, rewriting the dependent claim into an independent claim form, accompanied by abandonment of the original broad independent claim, creates a presumption of “prosecution history estoppel” that nullifies the “abandoned” claim. As a result, patent applicants will probably be more prudent and narrowly focused when considering use of broad independent claims.

For outsourcing, this means that only narrowly defined claims will pass muster.  Outsourcing services providers hoping to rely on patent protections will therefore be exposed to greater risks of competition due to lack of broad patent monopoly.

Defenses by Alleged Infringers.
The alleged infringer may allege various defenses, such as:

• non-infringement
• absence of liability for infringement
• inenforceability.
• invalidity of the patent or any claim for substantive or procedural reasons.  35 U.S.C. 282

Extraterritoriality in Patent Law.

Patent law is a creature of the national law.   Each country applies its own rules.  U.S. patents do not cover the business processes or manufacturing process used in another country.   John Mohr & Sons v. Vacudyne Corp., 354 F. Supp. 1113 (N.D. Ill. 1973).

However, goods made abroad using processes patented in the United States are subject to exclusion, upon importation, unless licensed by the U.S. patent holder.  Exclusion requires registration of the patent with customs services.  Enforcement of exclusion is hardly 100% effective.

Services performed abroad that result in delivery of information in the United States are generally not subject to U.S. patent protection.   In that case, where a portion of the services are rendered in the United States, a U.S. business process patent will cover the U.S. portion of the services.

Patent Conventions.
A number of international conventions, beginning with the Paris Convention of 1886, accords certain procedural rights in countries that adhere to them.   The World Trade Organization’s Agreement on Trade-Related Intellectual Property requires participating countries to comply with the Paris Convention and certain other intellectual property conventions.   WTO members must treat foreign nationals on a non-discriminatory basis in respect of the patent laws.  The Patent Cooperation Treaty provides a mechanism by which an applicant can file a single application that, when certain requirements have been fulfilled, is equivalent to a regular national filing in each designated Contracting State. There are currently over 112 PCT Contracting States.

Relevance to Outsourcing.

Patent protection — or the lack of it — can affect the service provider’s ability to perform the scope of work under the outsourcing services agreement.  Patents may be relevant to outsourcing, but not necessarily.

Comparative Advantage.
In the field of business process outsourcing, the service provider can achieve competitive advantage by having a patented process, since it allows that provider to perform that process without paying royalties and without patent infringement claims or litigation.

Defensive Strategy.
Having a pool of patents can be useful to avoid having to pay costs of infringement litigation and infringement damages.   Without any patents, the service provider has nothing to barter in a cross-licensing transaction that could be proposed as a settlement.

Branding Strategy.
One service provider uses part of the title to a U.S. patent as the phrase that defines its service brand: “On Demand Process….”  [U.S. Patent No. 6,370,676]    Public relations consultants and business developers might review the service provider’s patent portfolio for similar defining clues to brand development.  Conversely, branding strategists should be consulted for strategic nomenclature of patent applications.

Termination for Cause.
Ordinarily, the enterprise customer relies upon the service provider’s indemnity against infringement in lieu of adopting a right to terminate for cause in the event of infringement.  Such indemnities are customary.   Enterprise customers might wish to consider whether reliance on such indemnification is sufficient as a remedy in case the service provider’s business process is determined to be infringing on some third party’s rights.   Similarly, service providers should engage in appropriate research to determine whether their method of performing or delivering the services infringes, or risks infringing, a valid U.S. patent.   In either event, the issuance of new patents to cover existing processes could be problematic for the business relationship.

BPO Patent Strategy in Practice: Who Actually Patents What?

We conducted a search of U.S. patents issued to leading outsourcing service providers in information technology, human resources and manufacturing.  The results were not surprising.

• ITO and Consulting.
  Outsourcers that specialize in managing IT and in consulting services do not hold many patents.   Such service providers generally engage in “ordinary” and “well known” business processes that are ineligible for patenting, such as installing, configuring, fine-tuning, hosting and maintaining current versions of some commercial “off-the-shelf” software.  Where the customer requires extensive customization, the work product normally belongs to the customer as a special project for a separate fee.  Alternatively, the parties agree that the service provider will own and market the work product under agreed financial and operating conditions.

  To the extent that ITO service providers do apply for patents, the patents tend to be in:

  • a niche area (e.g., a system for cashing checks for persons without bank accounts where the customer must engage in some self-service task, U.S. Patent No. 6,038,553), or
  • a generic function (e.g., data processing apparatus and corresponding methods for the retrieval of data stored in a database or as computer files, notably, methods and systems to facilitate refinement of queries intended to specify data to be retrieved from a target data collection, U.S. Patent No. 6,678,679).
• HRO.
  Outsourcers that specialize in human resources management generally do not hold any patents.  For example, a search of  two HRO industry leaders showed that neither owns any U.S. patent.

• Business Process Outsourcing.
  Business process outsourcing that relies upon software may be a good candidate for patent protection, but only for patenting the software.  At this stage, the difference between a software developer and a service provider gets murky.  Generally, BPO outsourcers do not pursue patent strategies but use other methods for protecting intellectual property and competitive advantage.  Exceptionally, they may patent their software to defend against third party software developers.
• Original Equipment Manufacturing.
  Outsourcers that serve as contract manufacturers logically focus energy on preserving their rights to conduct “contract manufacturing” in the United States and other countries.  Companies such as Celestica, Jabil Circuit, Sanmina-SCI and Solectron have each developed some patents that relate to generic operations, not to specific product designs or manufacturing processes unique to their customers.  As to the latter, the contract manufacturers require their customers to license any customer technology used in the manufacturing process, or at least refrain from suing over the contract manufacturer’s use of such process or any equivalents.

Factors Affecting an Outsourcer’s Patent Strategy.

Limitations of a Patent Strategy in Outsourcing.

Patent strategies depend on obtaining global monopoly through global patenting.  The limitations on patenting of business methods in a global digital economy suggest that patenting is not the solution for protecting a service providers proprietary processes.

• Costs of Global Patenting.
  Assuming that a service provider wished to achieve global exclusivity, it would have to file patent applications in at least the 112 countries that are members of the Patent Cooperation Treaty, in addition to dozens more.  The cost of prosecuting and maintaining patents is high, and could be worthless if “copycat” service providers were to infringe virtually all claims except for a few.

• Costs of Prosecuting Patent Infringers.
  A “plain vanilla” patent infringement lawsuit costs an estimated $750,000 as a minimum.   To such out-of-pocket costs, the patent holder must add the opportunity cost of the executive and technical personnel whose time is diverted towards the litigation process, the portion of their salaries, benefits and overhead allocable to the litigation process, and the costs of enforcing a judgment.

• Uncertainties of Patent Scope and Validity.
  The patent application process contains many uncertainties.  As to scope, under the Festo doctrine, any concession made by the applicant can be used as an “admission against interest” by a defendant.  Patent holders making a concession to the patent examiner in any country may be deemed to have made the same concession in all other countries.  Alleged infringers will scour the patent prosecution files in all relevant countries and look for such concessions.    As to validity, any prior art (including customary usages of the trade, the technical literature and other pre-existing patents) that is not disclosed to the patent office could jeopardize the entire patent.

• Risks of Counterclaims of Patent Abuse.
  In any litigation, the plaintiff risks counterclaims by the defendant.   In patent cases, the counterclaims could include antitrust violations subject to triple damages under U.S. law or  for simple damages as “abuse of dominant market position” under European Union law.  For market leaders, the costs of defending counterclaims can be greater than the costs of pursuing a basic infringement claim.  Also, where patent applications fail to disclose substantial prior art the use of the patents to monopolize a field of business activity could arguably constitute patent abuse.

• Inconsistencies of Law, Legal Systems and Results.
  Given the exclusive right of each country to adopt its own patent rules, service providers considering a patent strategy must accept the fact that what is patentable in one country might not be patentable in another country.   “Whipsaw” in application of legal principles leads to unpredictability and inequity.

• Loss of Secrecy.
  Because patents must be published to be enforceable, the inventor immediately loses all secrecy.  (Exceptionally, a few patents are not published where interests of “national defense” apply.)   Thus, pure “software” or pure “business method” might not be patentable in countries where competitors could use the software or method to perform the same service and export the results to the country that grants patent protection.   Given the availability (and advisability) of encryption technologies and privacy methods, the foreign use of the software or method would likely go undetected, with no resulting enforcement of patent rights.

• Gambling with “Best Embodiment” Rules.
  Sophisticated businesses -whether service providers or enterprise customers – engage in a game of hiding trade secrets and patenting a business process.  The rules of this game are limited by the principle that the patent application must disclose the “best embodiment” of the full process.

• The Business Process Paradox in the Outsourcing Life Cycle.
  Both parties in an outsourcing contract should understand the implications of what we call “the business process patent paradox.”   Patents owned by the service provider make it stronger against competition and may enable the enterprise customer to enjoy the benefits of the service provider’s innovation investments.  Yet, upon termination the customer would need to be converted to a non-infringing process or be given an evergreen patent license usable by the customer or its successor service provider. Perversely, this patent paradox may inhibit the basic efficiencies of outsourcing, namely, scalability, portability, transparency, audit ability and periodic renewal or replacement.  One exception applies.  In contract manufacturing, the customer might wish to patent its processes in the countries where infringement is most likely, such as by the contract manufacturer at the end of the OEM manufacturing agreement.

Advantages of Trade Secrecy.
Many outsourcing service providers prefer to retain their comparative advantage by using trade secrets.  Trade secret protection does not protect against patent infringement. Trade secrets do not provide adequate protection where the trade secret becomes generally known.   This risk is high in a digital global economy where information can be copied and stored in many ways that are not traceable to the authorized recipient of the trade secret.  Optimally, the service provider will develop and use proprietary software covered by patents.  Even then, the patents might not disclose the full process.

Best Practices.

Patents could play a pivotal role in the competitiveness, viability and continuity of services provided by a service provider.

Enterprise Customers.

• Enterprise’s Own Proprietary Processes.
  An enterprise customer that wants its service provider to perform “proprietary” business processes will need to consider the impact of that contractual requirement on its own risk profile, its willingness to indemnify the service provider appropriately and its ability to do, or hire others to do, alternative processes that are not infringing.  Hiring a service provider to perform such processes might contradict other commercial policies, such as not outsourcing “core” business processes and maintaining certain processes confidential as a competitive advantage, even though such confidentiality is customarily protectible under a non-disclosure agreement.
• Due Diligence and Selection Process.
  Enterprise customers should ask the service provider for a description and list of all patents that the service provider owns or has pending.
• Indemnification.
  The customary solution to patent infringement is to require the service provider to indemnify the enterprise customer in case of any alleged or actual infringement by the service provider of third-party patents and other intellectual property rights.
• Termination of Contract.
  Historically, intellectual property infringement is not an event of default in outsourcing contracts.  This situation will probably continue.  Other contractual solutions exist that may allow the customer to enjoy the benefit of the contract or to terminate.

Service Providers.

• Due Diligence.
  The service provider should ask the enterprise customer about any patents and other protect able intellectual property that the customer would require the service provider to use (or that might be needed to perform the agreed services).  As a defensive measure, the service provider should understand the applicability of any customer-owned patents and its impact on its own intellectual property strategies.

• Contract Provisions.
  The infringement indemnity may extend to the interaction between the customer and the service provider’s business methods and processes.  Appropriate allocation of liability and indemnification should be considered to avoid extending the infringement indemnity beyond processes that the service provider controls.