CLS Case Raises Bar for Business Method Patents, Sort of

When can a financial method be patented?

a) Always
b) Never
c) Sometimes
d) Don’t Know

If you answered sometimes, you would be legally right. If you answered don’t know, you would be practically correct.

Based on a recent US Supreme Court decision involving the global operator of a mega foreign exchange settlement system, financial software developers should proceed with caution before filing a patent application, say patent attorneys. They can’t simply stick ideas on a piece of paper, explain how they work on a computer, and think the US Patent and Trademark Office will bless their so-called “invention” with a patent. But there is still plenty of room left for interpretation.

Had the US Supreme Court ruled against CLS Bank International, it would have had to either shut down or pay Alice Corp. a licensing fee for its methodology. Imagine dozens of the world’s largest banks around the world — including Citi, JP Morgan and Bank of America Merrill Lynch — no longer able to settle their foreign exchange transactions or having to fork over higher fees to cover the patent-related charges.

Here is the case in a nutshell. Alice Corp., an Australian company, owns several patents on computerized system that helps firms settle financial transactions through an intermediary and not risk settlement failure. A third party acts as a middleman  by creating shadow accounts for counterparties, only allowing transactions to go through if the shadow account shows the counterparty has enough money to execute the purchase.

Just how complicated is its process? In court documents, Alice Corp. relies on seven pages to describe its methodology. In trying to debunk the merits of a lengthy explanation, Charles Duran, an attorney with Public Knowledge and the Developers Alliance, watered it down to a mere seven lines of code.

Although Alice Corp.’s website says the firm was created to launch a derivatives market, it acknowledges that its sole purpose since 2002 has been to sue for patent infringement. It just happens that its only target is CLS Bank. According to Alice Corp.’s website, its four patents are owned by founder Ian Shepherd, a former managing partner in the Melbourne office of McKinsey & Company. National Australia Bank, one of Shepherd’s former clients, nabbed a 50 percent stake as of 2000.

In 2002 Alice Corp. approached CLS Bank, which settles a whopping US$5 trillion in forex trades daily, to offer it a licensing contract for its methodology on the grounds it owned these four patents. CLS refused saying the patents were invalid because under US patent law, abstract ideas cannot be patented.

First round of litigation: in 2011 a US district court agreed with CLS on the grounds that Alice Corp.’s formula to use a financial intermediary to hedge against settlement risk is too abstract to be patented. Next round: in 2012 the US Court of Appeals for the Federal Circuit, the court system which addresses appeals of patent rulings, reversed the US district court’s decision. Round three: in 2013 ten judges of the full federal circuit court invalidated the patents, but could not come up with a majority ruling. Instead, they expressed seven different opinions making it difficult to understand the rationale behind their decision and any criteria firms should use to ensure that their patents are solid and not be revoked.

Now enter the US Supreme Court last month, finally: Writing for the majority, Justice Clarence Thomas said, “Merely requiring generic computer implementation fails to transform that abstract idea to a patent eligible invention.” In agreeing with CLS Bank, he added that Alice Corp.’s claims only “recited the concept of intermediated settlement as performed by a generic computer.” The method doesn’t improve the function of the computer.

The Supreme Court’s ruling, say legal experts, follows similar reasoning used in the 2010 case of Bilski vs Kappos, where it decided that a method of hedging risk was not eligible for a patent. “Like the risk hedging in Bilski, the concept of intermediated settlement is a fundamental economic practice long prevalent in our system of commerce,” wrote Thomas.

So now what? Technology companies and global banks hold large portfolios of supposedly valuable patents. Firms known as patent trolls, such as Alice Corp., create or acquire patents in order to monetize them by suing firms for patent breaches. In its decision, the Supreme Court did strike a blow against trolls by emphasizing what cannot be patented — namely an abstract idea. However, it didn’t explicitly explain what technology firms and banks should do to ensure their patents are on solid ground by adding to the abstract idea

Partners Mark Knedeisen and Christopher Wolfe of the law firm of K&L Gates have come up with the following criteria for what is and isn’t patentable.

Patentable: “The court did not hold that all business methods or methods for organizing human activity are abstract ideas,” say Knedeisen and Wolfe in a recent blog. “Claims directed to computer implemented business methods are likely to be patent eligible if they recite a non-conventionable use of a computer or improvement to computer or other technology.”

Non-Patentable: Combining an abstract idea with a general purpose computer. The claim must improve the functioning of the computer itself or improve any other technology or field, say Knedeisen and Wolfe. Also non-patentable:  a business method based on a “preexisting fundamental truth” or “fundamental economic practice.” Translation: the methods described in the cases involving Bilski and Alice Corp. weren’t novel.

The US’ highest court has consistently been skeptical of protecting ideas, lest it hamper innovation. While the Supremes just gave some strong hints about which patent will and won’t hold up, software and computerized process developers will likely remain in patent limbo, until they attempt to test their patents in court.