FORTUNE -- A hugely important patent case -- yes, another one -- is being heard by the U.S. Supreme Court Monday. It’s about the patentability of computer-implemented, business-method patents, a category that includes much software.
For the common mortal, the case, known as Alice Corp. v. CLS Bank International, is a frustrating one. It involves an “invention” that is so vague and inchoate that most of us would not consider it an invention at all, but rather just a prediction that someone else would eventually invent the thing being described.
Yet the case is a hard one nonetheless. Though dozens of companies and trade groups and law professors have submitted or joined so-called friend-of-the-court ("amicus") briefs in the case -- including IBM (IBM), Google (GOOG), Microsoft (MSFT), Macy’s, Facebook (FB), and Twitter (TWTR) -- and most of these commenters appear to be deeply skeptical of the validity of these patents, they can’t agree about precisely why they’re invalid. And that’s crucial. If the Supreme Court invalidates these patents for the wrong reason, patent examiners will be forced to deny, and lower courts to invalidate, tens of thousands of perfectly appropriate patents, which could damage what the Framers of our Constitution envisioned as the nation’s principal engine of innovation: the patent system.
The purported invention in this case is a computer-implemented method of mitigating risk in foreign currency transactions -- essentially ensuring that one party won’t default after the other party has already fully performed his half of the bargain. In 1993, an Australian named Ian Shepherd, a former managing partner at the Melbourne office of McKinsey & Co., filed the first of a series of patent applications that describe in generic terms a process for incorporating a trusted, third-party intermediary -- an escrow agent -- into a transaction. That alone, of course, is an age-old concept. But it then also describes the process of using a general purpose computer to effectuate interactions between the escrow agent and the parties. The patents were granted -- the first was approved in 1999 -- and Shepherd then assigned them to Alice Corp., a company he set up.
“So far as the record discloses,” write the attorneys for CLS Bank International -- the party Alice now claims is infringing its patents, “Alice has never built a computer system capable of settling transactions according to the claimed method, has never written instructions to program any computer to perform the method, and has never practiced any of the asserted claims. Rather, Alice’s business apparently consists of asserting these patents in litigation. Alice is thus what is commonly known as a non-practicing entity or a patent-assertion entity” -- or, of course, a patent troll, though CLS Bank stops short of using that pejorative term. The bank’s attorneys are led by Mark Perry of Gibson, Dunn & Crutcher.
Alice’s Shepherd declined to be interviewed for this article, citing the upcoming Supreme Court argument. According to Alice’s website, its mission is “to promote Alice Markets -- an innovative form of derivatives market.” Nevertheless, it acknowledges, “Alice’s resources have primarily been diverted to the CLS litigation which has meant that the company’s efforts to commercialize Alice have assumed a secondary role.”
Unlike Alice, CLS Bank International has devised a fully functional, computer-implemented risk-mitigation system tailored to the currency exchange market, which has been up and running since 2002. CLS Bank facilitates $5 trillion worth of transactions involving 17 different global currencies each day. (Last September The Economist referred to CLS Bank as “the most important bit of the financial infrastructure you have never heard of.”) Owned by the 63 global banks it serves, CLS Bank is overseen by 22 central banks around the world and is considered a “systemically important financial market utility” by the U.S. Treasury’s Financial Stability Oversight Council.
According to CLS Bank, international bankers began discussing the need for a risk-mitigation entity like CLS Bank after the collapse of Bankhaus Herstatt, a small bank in Cologne, Germany in 1974. The problem gained renewed urgency in the early 1990s, after the bankruptcy of Drexel Burnham Lambert Group in 1990 and the closure of Bank of Credit Commerce International in 1991. Talks on the subject were then convened by the Group of 20 nations. These eventually led to the formation of CLS Bank, whose initials originally stood for “continuous linked settlement,” the escrow system that the member banks devised to mitigate risk.
A month after CLS Bank finally started operations in September 2002, Alice contacted it, demanding a license. In 2007, with litigation imminent, CLS Bank sued Alice in federal court in Washington, D.C., seeking a declaratory judgment that Alice’s patents were invalid.
To understand what the case is really about, it’s useful to step back for a moment to locate it within its own legal landscape. We have to remember that a patent can be invalid for a number of reasons. To begin with, it will be invalidated if it is not “novel” (a term defined in Section 102 of the patent law). Alternatively, even if it’s novel, it will still be invalidated if it represents such a tiny, incremental advance over existing practices that the invention would be considered “obvious” to anyone in the field (a term defined in Section 103). A patent can also be invalidated if its terms are so “indefinite” that a reader can’t tell where it begins and ends, or because it’s so vague that the reader wouldn’t know how to build the invention even after reading the patent (concepts laid out in Section 112).
While Alice’s patents might well be vulnerable to attack on one or more of these fronts, CLS Bank has not challenged them (yet) on those grounds. It has, instead, challenged them on a more fundamental basis. It argues that they are so abstract as to tread upon “non-patentable subject matter,” a concept defined in Section 101. This category of failing is hard to establish because the Supreme Court has, at least once, endorsed the view that “anything under the sun that is made by man” qualifies as patentable subject matter. Still, the Court has also consistently recognized the following three things as being not patentable under Section 101: “laws of nature, physical phenomena, and abstract ideas.” Last year, for instance, the Court invalidated a patent that had been obtained by Myriad Genetics upon naturally occurring DNA strands, which the Court held to be a nonpatentable product of nature. Similarly, in 2012, it struck down another patent, obtained by Prometheus Laboratories, which it found to describe “a law of nature” -- there, the correlation between levels of certain drug metabolites in the blood and likely harm to the patient.
CLS Bank contends that Alice has tried here to patent a nonpatentable “abstract idea.” The bank relies primarily on the Supreme Court’s June 2010 ruling in Bilski v. Kappos, which invalidated a business method patent on a way of hedging risk in commodities trading. In Bilski, the Court stopped just short of categorically rejecting all business-methods patents -- the vote was 5-4 to allow them -- but unanimously invalidated the particular patent before them anyway. They said the patent simply described a nonpatentable abstract idea: the basic economic concept of hedging. CLS Bank contends that what Alice has done is closely analogous; it has tried to patent “the basic economic concept of intermediated settlement or escrow.” The mere fact that Alice’s abstract idea, unlike the one in Bilski, is also described as being implemented by “conventional computer functions does not transform Alice’s ineligible claims into eligible ones,” its attorneys argue.
Alice argues that the “abstract idea” exception is actually much narrower, applying “only to those preexisting fundamental truths, such as mathematical formulas, that are ‘equivalent’ to a law of nature and that ‘exist in principle apart from any human action.’” (The interior quotes are from the Supreme Court’s decision in the Prometheus Laboratories case of 2012.) Alice is being represented at the Supreme Court level by Carter Phillips of Sidley Austin, who will be making his 78th argument before the Court, more than any other lawyer in private practice.
Part of Phillips’ argument will also likely be that the Bilski ruling of 2010 -- requiring lower court judges and patent examiners to determine what is and isn’t too “abstract” an idea to pass the threshold test for patentability -- just isn’t working out very well as a practical matter. And the best evidence of that is the U.S. Court of Appeals for the Federal Circuit’s unintelligibly fractured ruling in the CLS Bank itself in July 2012. Two years after Bilski, and four months after the Prometheus Labs case, that 10-judge court issued an array of six opinions in the CLS Bank case, and was deadlocked 5-5 on the validity of a number of claims in Alice’s patents. (Each patent is composed of multiple claims, and it only takes one valid, infringed claim to create liability.)
When one remembers that the Federal Circuit is a specialized, expert court -- every patent case appealed from any district court in the country goes to it, and patent and trademark cases make up nearly all the cases that court handles -- the fact that even this court didn’t have a clue how to interpret the Court’s “abstract ideas” precedents conveys the depths of the crisis that exists, and the urgency of the need for the Supreme Court to somehow supply more guidance this time around.
That crisis is why some observers, including IBM -- while quite dubious of a whole genre of patents that Alice’s exemplify -- think that courts should not be focusing on whether they constitute patentable subject matter (under Section 101), but rather, for instance, on whether they are too “obvious” (under Section 103) or too “indefinite” (under Section 116).
“In my view,” says Dave Kappos, the former director of the U.S. Patent and Trademark Office, who is now a partner at Cravath, Swaine & Moore, “the Supreme Court is searching for answers in the wrong places. It needs to reduce its reliance on Section 101. The validity of patents like these could be analyzed much more easily by looking at 102, 103, and 112.”
Tim Holbrook, an intellectual property professor at Emory University School of Law, is also of this view. “Section 101 is an incredibly blunt instrument,” he says in an interview. “If you’re worried about whether it’s an abstract idea, maybe there are other tools to deal with it,” he says, suggesting, again, the concepts of “obviousness” and “indefiniteness.”
Nevertheless, among the corporations that submitted or joined amicus briefs in the case, only IBM appears to take this position. All the others -- as well as the U.S. Solicitor General Donald Verrilli, Jr., speaking on behalf of the PTO and the White House -- urge the Court to invalidate Alice’s patents here and now, as “abstract ideas.”
The following are excerpts from several amicus briefs reflecting how different companies and public interest groups view the case. Several, as you will see, view it as a possible referendum on the patentability of software patents generally.
Google, Amazon (AMZN), Facebook, Verizon (VZ) et al.: “Patents that merely claim abstract ideas implemented on computers or over the Internet are invalid ... Such patents contribute nothing meaningful to the abstract idea. Instead, the significant work comes later, when others undertake the innovative task of developing specific applications ... Abstract software patents have become a plague on computer-related industries ... Far from promoting innovation, abstract software patents have impaired it by granting exclusive rights over high-level ideas and thereby blocking others from undertaking the truly innovative task of developing specific applications.” (Brief written by a team led by Daryl Joseffer at King & Spaulding.)
IBM: “The fact that the Court is now -- in 2014 -- actively considering such a basic question as whether computer-implemented inventions such as software are even eligible for patent protection is deeply troubling ... Computer-implemented inventions will always fall outside the abstract idea exception and are patent eligible under Section 101 ... As the Court has recognized, ‘all inventions at some level embody’ an abstract idea ... And unlike laws of nature and natural phenomena, abstract ideas defy the demarcation of meaningful boundaries that make the development of clear and administrable rules possible ... To be sure, patents that do no more than implement an otherwise abstract idea on a computer through conventional programming raise concerns ... and such patents are part and parcel of a larger challenge facing our nation’s patent system ... [T]he answer to this ... concern actually lies in Section 103’s bar on obvious patents.” (Attorneys led Paul Clement of Bancroft PLLC.)
Microsoft, Adobe Systems (ADBE), Hewlett-Packard (HPQ): “Petitioners’ patents claim a method of performing escrows -- an otherwise unpatentable business method -- to which petitioner has essentially bolted on the directive ‘perform that method on a computer.’ But merely saying, ‘perform an otherwise unpatentable idea on a general-purpose computer’ does not make the idea patentable ... Because this case does not involve a true computer-implemented invention (but rather a business method posing as one), the Court has no reason to address -- or to risk the potential uncertainty and unforeseen impacts that can be created by addressing -- the patentability of computer-implemented inventions and software generally ... Software-based innovation pervades every sector of the economy. In the aerospace and automotive industries, innovations like fly-by-wire controls and anti-lock brakes are not so much the product of mechanical evolution as of software advances. Such computer-implemented innovations have been considered, and should remain, just as patent eligible as their mechanical predecessors.” (Attorneys led by Jeffrey Lamken of MoloLamken.)
LinkedIn (LNKD), Netflix (NFLX), Rackspace (RAX), Twitter, et al.: “Software patents do not serve the Constitutional purpose of the patent system: to promote the progress of science and the useful arts ... The undersigned believe that innovation happens despite software patents, not because of them ... Our programmers (like programmers generally) overwhelmingly oppose software patents.” (Attorneys led by Mark Lemley, an attorney at Durie Tangri and a leading patent scholar at Stanford Law School.)
Dillard’s, Hasbro (HAS), J.Crew, L.L. Bean, Macy’s, National Restaurant Association, and other retailers: “The retailers seek a clear rule of law concerning patentability that can be applied at the beginning of a lawsuit ... Computer-implemented patents are among the fastest growing category of patents, the patents most likely to be litigated, and the patents least likely to be found valid and infringed if litigated to the bitter end.” (Attorneys led by Peter Brann of Brann & Isaacson in Lewiston, Maine.)
Software Freedom Law Center, Free Software Foundation, Open Source Initiative: “Computer programs are algorithms for computers to execute ... Standing alone, without specialized machinery ... they are not patentable ... Innovation in software, like innovation in mathematics, is encouraged by scientific processes of free sharing and open publication, not by granting state-issued monopolies on ideas.” (Attorneys led by the center’s director-counsel Eben Moglen, who is also a professor at Columbia Law School.)