The way of the Mastodon

I was having lunch the other day with the GC of a company that facilitates internet sales. I laughed when he told me a story about having to identify an attorney who could advise him on whether there were laws that applied to the sale of Mastodon remains. (Amazing what people have in their garages, these days.)

It was a reminder of the need for technical legal experts that you can turn to for specific help. While I believe that companies will always have this need, the way that we identify and connect with that expertise is quickly changing. And, this will lead to a change in the traditional model for the delivery of legal services – the law firm.

Let me begin by asking – what is the function of the law firm? My view is that law firms serve primarily as aggregators of specialized legal expertise. The premise has been that by combining multiple legal disciplines you can provide “one stop shopping” for current and prospective clients. This structure previously made sense. If you were an individual or business with a legal problem, it wasn’t efficient nor effective to try to identify an individual attorney with the technical skills that you required. So, you would turn to a law firm and rely on them to direct you to the appropriate attorney within their firm to solve your issue. The problem is that this model relies on growth (the need to add additional attorneys) to maintain profitability rather than focusing on efficiency gains. In this respect, it is at odds with what I need as a client and General Counsel.

As with so many things, the Internet is changing this business model. It is getting increasingly easier to move the aggregation function in-house. To find an attorney in a specialized area, I don’t need to turn to a large law firm. Instead, I send out an email to my network of other in-house attorneys or within professional associations like the ACC and get referrals. Not only that, but I get true “customer feedback” that is more objective than what I would get from a firm. There is now a proliferation of materials available on the web – judicial opinions, legal commentary and press articles that also provide information about attorneys.

The result is that we are increasingly able to identify and engage specific legal talent directly. Here’s an example. Like all large companies, we have a certain amount of employment litigation. Almost all of the large firms have strong employment law practices. But, we use a very small firm for much of this work. Why? They focus only on employment law, are very good at what they do, understand our business, get excellent results and are very cost effective. They don’t have the overhead of supporting attorneys practicing in other areas.

My point is that the epoch of the current law firm model – which derives its profitability from growing scale and raising hourly rates – will soon be over. The firms that will survive and thrive are those that recognize this change and focus on how to maintain margins by focusing on efficiency. In the future, I’ll describe some the things we are doing in this area, but I’ll point out that we recently selected a small number of law firms to support us as “preferred partners” during the next fiscal year. We believe that these firms “get it” and are receptive to looking at new ways to drive down their (and our) cost structure. Hopefully, more firms will embrace this change. If they don’t, I fear they will go the way of the Mastodon.

Cautiously Optimistic

Last month, we were hit with two new patent troll cases. With each, there was no warning, no offer to license – just a lawsuit. And, who are these “aggrieved” plaintiffs? In the first case, the litigant is a company called “Exponential Systems”. Exponential alleges that our Sun Grid Compute Utility infringes their patents. So who is Exponential? Are they creators of competing technology? Do they invest in R&D? Do they create products and jobs that add value to society? Hard to tell, but I doubt it. All we know is that the original patents were owned by a company called “Hemisphere II Investments”, which then transferred the patents to Exponential for the grand sum of $5.

Seriously. We are being dragged into expensive litigation and this is all we know about the other party. Even more frustrating is that one of the primary goals of our Sun Grid is to drive down the cost of computing. I’ve written previously about this tax on innovation. This is a real example.

And, as to the second case, let me ask – what do Sun, Google, Metacafe, Sony and 15 other companies (including several in the internet “adult entertainment” business) have in common? If you answered that all were recently sued by a patent holding company called “Antor Media” you would be correct. And what do we know about this plaintiff? Little except they have a history of suing everybody. In this specific case, no Sun products are even identified in the complaint. Yet, we now need to hire outside counsel and plan a visit to the Eastern District of Texas where this case has been filed.

You may believe that these are isolated examples. However, during the same time Sun was sued in these two cases, eight mobile phone companies, four major internet retailers and three computer companies were all sued for infringement by patent holding companies.

If this sounds like a waste of time, money and resources – it is. But, there have been some recent changes, both legislative and judicial, that make me feel at least a slight bit optimistic for a change.

On April 18th of this year, a bipartisan and bicameral bill was introduced in Congress entitled the “Patent Reform Act of 2007”. This legislation builds upon legislative proposals introduced last year. Included in this proposed legislation is:

-A limitation on patent venue (commonly referred to as “forum shopping”).

-The creation of a post-grant proceeding to cancel a patent after issuance. This is in recognition that the current methods for challenge – PTO reexamination or litigation – are not effective nor efficient.

-Changes that will make it more difficult to demonstrate willful infringement, a finding of which is subject to treble damages. It also limits damages to a reasonable royalty for the invention itself instead of the value of the product into which an invention may be incorporated. (This one would go a long way toward making these litigations less attractive.)

-Creation of a first to file system. Interestingly, the U.S. is currently one of the only countries that grants patents to the first to invent instead of the first to invent and file.

Recently, the U.S. Supreme Court also announced two important decisions that provide more immediate relief. In Microsoft v. AT&T Corp. the court ruled 7-1 that “golden masters” shipped by Microsoft for installation on computers made and sold abroad are not “components” pursuant to 35 U.S.C. Sec. 271(f). Under U.S. patent law, no infringement occurs when a product that is the subject of a U.S. patent is made or sold in another country. It may be an infringement of a foreign patent, but U.S. patent laws do not apply. The exception is Section 271(f) which was enacted in 1984 in response to a case involving (of all things) shrimp deveining equipment. The defendant in that case conceded that it was prohibited from making or selling the infringing equipment in the U.S., but successfully argued that there was nothing in the law that prevented it from making the components for the equipment in the US and then having the assembled abroad.

In the current case, Microsoft conceded that it infringed AT&T patents related to digital speech compression. But, they objected to AT&T’s claim that a golden master should be considered a component under 271(f) and Microsoft, accordingly, liable for foreign damages.

In siding with Microsoft’s position, the court has brought some rationality into the world of software patents. Indeed, many in the software industry have been watching this case closely and considering whether (assuming the original decision was unchanged) it would be a reason for moving development efforts offshore.

The other decision – KSR v. Teleflex – was important because the court made it easier for the PTO and defendants to challenge questionable patents consisting of combinations of elements on the basis of “obviousness”. It is a basic tenet of patent law that things that are “obvious” are not subject to patent protection. As the court noted in an earlier case, allowing an obvious combination of components “withdraws what is already known into the field of its monopoly and diminishes the resources available to skillful men.” But what is obvious is not always clear, especially in the case of a claimed invention consisting of a combination of elements. In KSR, the dispute was whether it was obvious that electronically adjustable automobile pedals would replace mechanical ones. The Federal Circuit applied what is known as the TSM (“Teaching, Suggestion, Motivation”) test to determine whether the electronically adjustable pedal configuration was obvious. Under this test, the court seeks written evidence – for example, scholarly works or something published – to support a finding of obviousness.

In overturning the lower court decision, the Supreme Court unanimously recognized that the TSM analysis was too limiting: “In many fields it may be that there is little discussion of obvious techniques or combinations, and it often may be the case that market demand, rather than scientific literature, will drive design trends.”

The result of this decision, is that there will be increased scrutiny as to what truly constitutes innovation. And, indeed, just last week, in a case involving competing manufacturers of electronic toys, the Court of Appeals of the Federal Circuit relied on KSR to find that the underlying patent was invalid as obvious.

Some commentators are suggesting that the KSR case will hurt hardware and software companies that combine and change components to create new products. Sun is just such a company. Our R&D investment has lead to innovation in hardware, software, storage, servers and microprocessors. We leverage the best of all of these as components when engineering new systems. So, yes, the commentators might be right, but only to the extent that we were focused on creating revenue from litigation of questionable patents – instead of satisfying customers.