Tax Planning Patents Dodge a Potentially Fatal Bullet in Bilski

Tax Planning Patents Dodge a Potentially Fatal Bullet in Bilski
By Michael B. Lang and William A. Drennan

Chapman University School of Law, Southern Illinois University School of Law, and Husch, Blackwell, Sanders LLP, Orange, CA, Carbondale, IL, and Washington, DC, respectively.

On June 28, 2010, the U.S. Supreme Court issued its long-awaited opinion on the ability of inventors to patent a process.  In a major victory for inventors holding (or seeking) patents in numerous fields, including computer software, financial services, insurance strategies, and tax planning, a 5-4 majority of the Court affirmed that at least some business methods may be patented. The practical impact of this decision is that taxpayers and their advisors can no longer reasonably hope that a court will ultimately invalidate a tax planning patent on the ground that a business method can never be patented. The Court's opinion, however, fails to address many other critical issues for tax plan inventors and for taxpayers and their advisors contemplating either licensing a tax strategy or proceeding with a tax planning strategy without a license and risking a patent infringement lawsuit.

The U.S. Patent & Trademark Office (the "Patent Office") reports that as of July 4, 2010 it has issued 107 tax planning patents involving tax strategies as diverse as a like-kind real estate exchange, a charity's purchase of a commercial annuity to fund payments under a charitable gift annuity, a conversion of a traditional IRA to a Roth IRA, and the contribution of stock options to a GRAT to generate estate tax savings. Another 145 applications for tax strategy patents were then pending in the Patent Office.

Brief Background of Bilski. The U.S. patent statute provides that a patent may only issue for a novel, non-obvious invention that falls within one of four subject matter categories: (i) a process; (ii) a machine; (iii) a manufacture; or (iv) a composition of matter. 35 USC §101. The courts have held that an "abstract idea" cannot be patented. Diamond v. Chakrabarty, 447 U.S. 303, 309 (1980). For almost 90 years, a process constituting a business method was not patent eligible because it involved a series of ideas and because a patent for a business method could grant an inventor a powerful monopoly on conducting business in an entire industry, which the courts found objectionable as a matter of policy. SeeHotel Security Checking Co. v. Lorraine Co., 160 F. 465 (2d Cir. 1908). In 1998, the Federal Circuit rejected the 90-year old business method exclusion and stated "business methods have been, and should have been, subject to the same legal requirements for patenting as applied to any other process or method." State Street Bank and Trust Company v. Signature Fin. Group, Inc., 149 F.3d 1368, 1375 (Fed. Cir. 1998). The Federal Circuit's opinion in State Street Bank opened the floodgates at the Patent Office; inventors filed more than 11,000 patent applications for business methods in 2007 alone.

If patents on business methods are not prohibited, numerous important questions arise regarding when a business method is patent eligible. Nevertheless, in Bilski, the U.S. Supreme Court declined to address these questions and instead chose to focus on the threshold issue – whether the Federal Circuit was correct in rejecting the 90-year-old business method exclusion.

Bilski: Facts and U.S. Supreme Court's Majority Opinion. Bilski applied for a patent for a method of hedging risks in the energy market. With Bilski's invention, energy producers, purchasers and other participants in commodities markets could minimize the risks resulting from fluctuations in market demand for energy through a series of transactions at fixed rates based upon historical averages. The business method in Bilski did not require a computer or other machine.

The Supreme Court's majority opinion focuses on whether business methods are per se non-patentable. The author of a leading patent law treatise asserts that a group of four Justices (Justices Stevens, Ginsburg, Breyer, and Sotomayor) initially believed the Court would conclude as a matter of law that business methods cannot be patented; those Justices arranged for retiring Justice John Paul Stevens to draft a voluminous (47-page) opinion condemning business method patents by relying extensively on the history of English and U.S. patent law as well as modern scholarly commentary. But the four Justices were unable to persuade a fifth Justice to join in an opinion prohibiting business method patents. Justice Kennedy then drafted a comparatively brief 16-page opinion; Justice Scalia declined to join in two sections of Justice Kennedy's opinion, so only approximately 13 pages of Justice Kennedy's 16-page opinion reflects the majority view. See Donald S. Chisum, "Notes on Bilski," June 29, 2010, available at http://www.chisum.com/current-developments/bilski-watch/notes-on-bilski.

In concluding that business methods may be patented, Justice Kennedy's majority opinion relies heavily on an attempt by Congress to limit the enforceability of business method patents.  Shortly after the Federal Circuit rejected the 90-year rule that business methods could not be patented, Congress in 1999 enacted a new defense to protect prior users from being sued for infringement of a business method patent. See 35 USC §273. Justice Kennedy's opinion seizes on the fact that Congress merely protected some users of such patented business methods from enforcement actions, rather than prohibiting the granting of business method patents altogether, as evidence that Congress in 1999 was "clarify[ing]" that business methods are a kind of "method" or "process" that may be patented.

Despite furthering an expansive view of business method patentability generally, the Court concluded in Bilski that the particular invention involved is not patentable because the concept of hedging and its reduction to a mathematical formula together constitute an "unpatentable abstract idea," and the restriction of the abstract idea to one particular field (the energy industry), like the addition of mere "token post-solution components," is inadequate to transform the invention into a patent-worthy "application of a law of nature or mathematical formula."

Practical Impact for Tax Planning Patents.  In order to be patentable, an invention must fall within one of the four categories – (i) a process, (ii) a machine, (iii) a manufacture, or (iv) a composition of matter. Although some Federal Circuit cases, such as In re Alappat, 33 F.3d 1526 (Fed. Cir. 1994), might be read to indicate that a method relying heavily on a computer could qualify as a "machine," intuitively a tax planning strategy would seem most likely to fit within the "process" category. Indeed, the Patent Office established Class 705 for "business method patents," and the Patent Office includes tax planning inventions in Subclass 36T of Class 705. Thus, if the Supreme Court had ruled that business methods could not be patented, the most likely avenue for patenting a tax planning strategy would have closed. Although four of the Justices were willing to declare all business methods non-patentable, it seems unlikely that the Court will re-visit the issue any time soon. Even with a major shift in the Court's personnel, which is unlikely to result from the retirement of Justice Stevens, respect for precedent would discourage a reversal.

For more information, in the Tax Management Portfolios, see Faulk and Stevens, 557 T.M., Tax Planning for the Development and Licensing of Patents and Know-How.