From the May 1999 issue of Entrepreneur

A watershed event occurred in the world of patent law last July. The U.S. Court of Appeals for the Federal Circuit issued an opinion in the case of State Street Bank & Trust Co. v. Signature Financial Group Inc. that put to bed such important patent questions as whether a patent can be granted for the way you do business and whether you can receive a patent for software. The answer to both questions is now yes.


Tomima Edmark, the woman famous for her Topsy Tail invention has now turned her creative talents to the competitive retail arena of intimate apparel, HerRoom and HisRoom.

Laying the Groundwork

In its dealings with patent-related cases over the years, the Supreme Court has established a record for excluding three categories from receiving patents. The first is laws of nature, such as gravity. Natural phenomena are also unpatentable. Patents aren't granted for the discovery of phenomena such as electricity or fire. However, patents can and have been awarded for ways to make electricity or fire.

The third unpatentable category is abstract ideas. A mathematical algorithm (a step-by-step problem-solving method), for example, was not patentable. Such an algorithm was considered an abstract idea because it's not substantive; it's just a theoretical concept or truth. It's this third area that's recently been challenged in court and in the U.S. Patent and Trademark Office (PTO), because computers and software make extensive use of mathematical algorithms and their use of such processes has become very valuable in the business world.

In addition to these three unpatentable areas determined by the Supreme Court, the PTO has been of the opinion for many years that a fourth area of unpatentability exists: methods for doing business. In its view, business methods aren't tangible and don't fall within any category of patentable ideas. For example, one business method involves lowering prices to increase sales. If you had been the first person to do this and could have filed a patent on it, no one else would be able to lower prices to increase sales without paying you a royalty. Since there's nothing tangible about a business method--it's just a way of doing something--the PTO has historically state that business methods can't be patented.

This bias of the PTO dates back to at least 1908, according to Joel S. Goldman, an intellectual property attorney at Troutman Sanders LLP in Atlanta. In the case of Hotel Security Checking Co. v. Loran Co., the court held that the patent in dispute, which covered a bookkeeping system, was invalid because it didn't fall within a patentable category.

It wasn't until 1983 that this beachhead opinion began to crack. Brokerage firm Merrill Lynch owned a patent for a system of combining a brokerage security account, a money market fund and a charge/checking account. In a patent dispute, the courts found Merrill Lynch's system did indeed contain patentable subject matter. In fact, the court's opinion went further and gave great weight to the fact that a computer carried out the method described in the patent. This established the precedent that the use of a computer to perform a business function was indeed patentable. Thus, a mathematical algorithm and a method for doing business were, for the first time, awarded patents.

Then in 1996, Federal Circuit Court Judge Pauline Newman made a ruling that patentability should not be determined based on whether the patent can be pigeonholed into a "business method" niche. Rather, consideration should be placed on the idea's technological usefulness as well as its newness and nonobviousness.

Defining Moment

With all this background in mind, here's why the State Street Bank decision has proved to be such a landmark case. U.S. Patent No. 5,193,056, titled "Data Processing System for Hub and Spoke Financial Services Configuration," was issued to Signature Financial Group Inc. in March 1993. The patent covered a business structure wherein mutual funds (the spokes) pool their assets in an investment portfolio that's organized as a partnership (the hub). This structure allows fund administrators to monitor and record financial information, and make necessary calculations and allocations within the partner fund structure.

State Street Bank & Trust Co. wanted to use Signature's patented business procedure, but its licensing negotiations with Signature failed. Subsequently, State Street sued to declare Signature's patent invalid. In his ruling, Federal Circuit Court Judge Giles Sutherland Rich declared "anything under the sun that is made by man" to be patentable subject matter. He went on to say that the courts should not take it upon themselves to create limitations on what is and isn't patentable.

Additionally, the court also cleared up the mathematical algorithm issue. Courts are now instructed to focus on whether an algorithm is applied in a useful way and not look at algorithms as just abstract ideas.

What It All Means

Because of these rulings, business methods and mathematical formulas are now on the same footing as other types of patents, and the software industry now has a powerful new legal tool. "There are no more barriers to patenting software, and because of this, the entire industry is adopting an aggressive strategy in obtaining patent protection," says Jerry Mills, a patent attorney for Baker & Botts in Dallas.

Q. Todd Dickenson, the PTO's Acting Commissioner, has added 20 new patent examiners to the division responsible for reviewing e-commerce patents. Dickenson predicts that by the end of 1999, more than 300 business method patents could be issued.

These new types of patents will be very important and highly valuable to small and start-up companies. Businesses owning such patents will be attractive to investment capital firms looking for investment opportunities. These patents could also be useful to small companies looking to make initial public offerings.

On the other hand, this ruling should cause some concern. Although the worldwide effect of the State Street Bank ruling remains to be seen, traditionally, more patents lead to more lawsuits. Also, entrepreneurs just starting businesses may find, some time down the road, that their way of doing business has been patented by someone else. They'll then need to pay a licensing fee to the patent holder or quit the way they've been doing business.

If your way of doing business is heavily dependent on computer software or a particular business method, you'll need to evaluate your intellectual property and determine whether a patent makes sense for you. Your planning should include not only an evaluation of the valuable opportunity such a patent can bring, but also the risks involved should someone else patent your idea first.

Fast Track

Name and age: Wyatt Earp IV (yes, he's the third-generation descendant), 35

Company name and description: Burn Out Wear LTD creates high-quality apparel such as T-shirts, sweatshirts and hats bearing authentic rubber tire marks and NASCAR serial numbers used by professional motorsports teams. After ruining many shirts, smashing a mannequin's head (don't ask) and using his mother's couch cushion to test his concept, Earp designed a customized machine to produce the burn-out effect on apparel.

Based: Waterloo, New York

Founded: 1997

Start-up costs: $100,000

1998 sales: $150,000

1999 projections: $3 million

Yeah, but was it America's Funniest? Earp got the idea for his apparel in 1994 while watching a TV program in which a man shot holes in blue jeans with bird-shot, then sold them for profit. Thinking if someone could sell jeans with holes, he could sell T-shirts with burn-out marks on them, Earp laid shirts in his driveway, then drove over them trying to create the marks. Shirts flew everywhere, and some burned. He decided a special machine was necessary to create the mark.

We're not laughing: "My biggest fear was that people would think my idea was a joke," says Earp. But he's had the last laugh: "To date, not one person has made a negative comment. Everyone I've shown it to says, `Cool.' "

From the driver's seat: "You find out very quickly that you're the only one who really cares about your vision," says Earp. "Go with what you think, and don't listen to others' suggestions."

Contact Sources

Baker & Botts, (214) 953-6665, jmills@bakerbotts.com

Burn Out Wear LTD, (315) 539-0875, http://www.burnoutwear.com

Patterson, Belknap, Webb & Tyler LLP, 1133 Ave. of the Americas, New York, NY 10036, jidlewis@pbwt.com

Troutman Sanders LLP, (404) 885-3144, joel.goldman@troutmansanders.com