Federal Circuit Issues Landmark Decision on Business Method Patents

The U.S. Court of Appeals for the Federal Circuit issued a long-awaited decision that could make it more challenging to patent business processes such as tax and financial strategies.

In a 9-3 ruling issued on Oct. 30 in the In re Bilski case, the court stated a new, more stringent test for the patentability of business methods. Bernard Bilski applied for a patent covering a method of hedging risk in commodities trading. The court held that the hedging method was not eligible for patent protection because it did not pass the machine-or-transformation test—it was not “tied to a specific machine” and did not “transform a particular article to a different state or thing.”

Although the decision does not specifically address tax strategies, the court adopted many of the positions that the AICPA urged in an amicus brief, according to Richard I. Miller, general counsel and secretary for the AICPA. The Institute has worked with members of Congress on proposed legislation to address tax strategy patents. The House version of the Patent Reform Act of 2007 included an amendment of the same section of the Patent Act at issue in Bilski, 35 U.S.C.§ 101, to make tax strategies not subject to patent protection (H.R. 1908). Although the Bilski opinion will make it more difficult to obtain and enforce patents on tax strategies and other business methods, the AICPA will continue to work to amend the Patent Act to make tax strategies unpatentable.

The AICPA explained in its amicus brief (written with Kelsey Nix and Heather Schneider of Willkie Farr & Gallagher LLP) that tax strategies are not proper patentable subject matter under Section 101 of the Patent Act or the Patent Clause of the Constitution because they preempt the public’s free use of certain provisions of the tax laws, don’t meet the Supreme Court’s criteria for the patentability of processes, and fail to promote the useful arts.

A flood of patent applications over the past decade has focused on methods of doing business. The Federal Circuit’s 1998 decision in the State Street Bank case opened the flood gates. That case held that a method of doing business could be patented. As of Oct. 30, the U.S. Patent and Trademark Office Web site listed 71 issued patents and 118 pending applications in the subclass for “tax strategies”(subclass 36T in Class 705). Patents for tax strategies have been granted in a variety of areas, including the use of financial products, charitable giving, estate and gift tax, pension plans, tax-deferred real estate exchanges and deferred compensation.

The issue in Bilski was how to determine what is a “new and useful process.” The court focused on a 1981 Supreme Court decision, Diamond v. Diehr, 450 U.S. 175, 185, that held that a claim is not patentable if it claims “laws of nature, natural phenomena, [or] abstract ideas,” which the Bilski court defined as “fundamental principles.” The court explained that they are “part of the storehouse of knowledge of all men … free to all men and reserved exclusively to none.” The AICPA’s amicus brief urged that man-made laws, like these fundamental principles, should likewise be available to all taxpayers.

The court adopted a “machine-or-transformation” test for patentability and specifically overruled State Street’s broader “useful, concrete and tangible result” test. The machine-or-transformation test is the set of criteria that the Patent Office and the courts now must use to determine whether a process is patentable or instead is an unpatentable fundamental principle. Importantly, the court explained that merely reciting some machine or some transformation in the patent claims is insufficient. Instead, “the use of a specific machine or transformation of an article must impose meaningful limits on the claim’s scope” and “not merely be insignificant extra-solution activity.”

The court left to another day “whether or when recitation of a computer suffices to tie a process claim to a particular machine.” Therefore, since tax strategy patents that recite a specific computer system could still be granted, legislation will still be needed to prohibit tax strategy patents or provide immunity for taxpayers and practitioners from liability for such patents, Miller says.

On the transformation part of the test, the court explained that the transformation of an article into a different state or thing “must be central to the purpose of the claimed process.” The “article” that is being transformed is also key to patentability. The court characterized legal obligations, legal relationships and business risks as examples of “abstractions” that “cannot meet the test because they are not physical objects or substances.”