The IP Law Blog

The Grokster Decision- What Does It Really Mean?

By Scott Hervey

On June 27, 2005, the United States Supreme Court handed down its decision in MGM v. Grokster.  That case involved an appeal from the Ninth Circuit by MGM, various record labels and other content owners of an adverse decision in their attempt to hold Grokster and other peer-to-peer network companies liable for copyright infringement.  MGM and the other content owners had initially filed a lawsuit against Grokster and other peer-to-peer network technology companies to hold them liable for damages resulting from their supplying the technology that enabled users to trade online copyrighted works.  The Ninth Circuit, upholding the District Court’s finding, held that the technology companies could not be held either vicariously liable or liable for contributory copyright infringement.  In coming to its conclusion, the Ninth Circuit interpreted the Sony v. Betamax case in holding that the distribution of a commercial product capable of substantial noninfringing uses could not give rise to contributory liability for infringement unless the distributor had actual knowledge of specific instances of infringement and failed to act on that knowledge.  Because the Ninth Circuit found the technology company’s software to be capable of substantial noninfringing uses and because respondents had no actual knowledge of infringement resulting from the software’s decentralized architecture, the court held that they were not liable.  (The architecture of the defendant’s file trading network is an open network.  That is, it does not have a central server like the old Napster network but rather uses nodes and supernodes; computer systems that are owned by users of the software and have no relationship to the defendants.)  The Ninth Circuit also held that the defendants did not materially contribute to their user’s infringement because the users themselves searched for, retrieved and stored the infringing files, with no involvement by respondents beyond providing the software in the first place.  Finally, the court held that the defendants could not be held liable under a vicarious infringement theory because the defendants did not monitor or control the software use and had no agreed upon right or current ability to supervise its use and had no independent duty to police infringement

The Supreme Court stated that the Ninth Circuit read the Sony case too broadly.  Instead, the Supreme Court stated that the test for contributory or vicarious liability revolves around the intent of the defendant, namely did the defendant distribute its device with the object of promoting the devices used to infringe the copyrighted works of third parties, as shown by clear expression on other affirmative steps taken to foster infringement.  If the defendant goes beyond mere distribution with the knowledge of third party action, the distributor is liable for the resulting acts of an infringement by third parties using the devices, regardless of the devices lawful uses.

What will this decision really do in the way of advancing the entertainment industry’s fight against illegal file trading, and how does this affect the growth of new technology?  Numerous pundits claim to have the answer.  However, human nature being what it is, I fail to see how anyone can predict the long term ratifications of this decision.  As a practical matter I believe that if a company creates a product with the primary intent that it be used for an illegal purpose, the company should be held liable.  If Grokster and the other defendants built a business model that depended on and encouraged users to engage in illegal file trading, then they should be held liable. 

Representing record labels, television production companies, and other content owners, I understand how piracy affects their bottom line.  However, if illegal activity is an incidental byproduct to an otherwise productive and beneficial technology that is a cost of societal advancement that content owners have to bear. 

The problem with the Grokster decision is how does one establish a company’s principal intent?  Unfortunately, unless the Company makes an express statement the only way is through litigation.  While I don’t think that the Grokster decision is death knell for new technology as some pundits declare, I do see how, as a result of this decision litigation can be used to slow or quash the growth of new technology.  This is a real possibility; especially when we are dealing with the entertainment industry.  I have found that some entertainment industry companies are reluctant to venture outside of their known safety zone.  They’re reticent to try new things that challenge or disrupt their existing business model.  From a business perspective, I can understand this.  Nobody likes to have their bottom line affected.  However, technological growth depends on innovative people pushing boundaries.  I would hate to see the Grokster decision slow technological advances that can, in the long run, be beneficial to all of us.

Claim Construction: A Little Less Uncertain But Still Just As Uncertain

 

By Audrey Millemann

The Federal Circuit Court of Appeals issued its long-awaited decision in the patent infringement case, Phillips v. AWH Corporation, 2005 WL 1620331 (Fed. Cir. July 12, 2005).  The en banc opinion is significant both for what it did hold and what it did not.

The court held that patent claims are to be interpreted in accordance with the specification, and that dictionaries should not be used in the first instance.  After requesting briefs on the broader question of whether a district court’s claim construction decision should be given any deference, and receiving over 30 amicus briefs, the court declined to reach that issue. 

The case involves a patent for modular steel panels that can be used to form walls.  The inventor, Phillips, sued AWH Corporation after AWH continued to sell the patented product after a license arrangement had ended.  The district court granted the defendant’s motion for summary judgment of non-infringement based on its construction of the term “baffle”.  A panel of the Federal Circuit affirmed the district court’s decision.  The court then granted Phillips’ petition for re-hearing en banc and reversed the grant of summary judgment. 

The key issue before the court was whether the patent’s specification should be the primary source for claim construction or whether extrinsic evidence (e.g., dictionaries) should control.  The court emphatically answered the question:  the specification is the first and best source for interpreting claim terms.  The court clarified its earlier decision in Texas Digital Systems, Inc. v. Telegenix, Inc., 308 F.3d 1193 (Fed. Cir. 2002).  The Texas Digital court had interpreted the claims using ordinary dictionary definitions rather than the specification, and had suggested that there is a presumption in favor of dictionary definitions such that the patentee would have to overcome that presumption in order to rely on the specification.  In Phillips, the court explained that the Texas Digital court had meant well in that it had intended to prevent “one of the cardinal sins of patent law – reading a limitation from the written description into the claims”, but that it had gone too far.  (Phillips at *12.) 

In describing the problem with using dictionary definitions, the court stated:  “The main problem with elevating the dictionary to such prominence is that it focuses the inquiry on the abstract meaning of words rather than on the meaning of claim terms within the context of the patent.  Properly viewed, the ‘ordinary meaning’ of a claim term is its meaning to the ordinary artisan after reading the entire patent”.  (Id. at *14.)  The court noted that the result of interpreting claims using dictionary definitions would be erroneously broad claims.  The court did not preclude the use of dictionaries, however, and noted that dictionaries and treatises are valuable aids for judges. 

The court acknowledged the concern of the Texas Digital court.  “[W]e recognize that the distinction between using the specification to interpret the meaning of a claim and importing limitations from the specification into the claim can be a difficult one to apply in practice.”  (Id. at *15.)  The court solved this problem with a generalization that most inventors do not intend to limit their claim terms to the exact embodiments described in the specification.  As to those cases that cannot be solved by this general rule, the court concluded that it had “not attempt[ed] to provide a rigid algorithm for claim construction, but simply attempted to explain why, in general, certain types of evidence are more valuable than others”.  (Id. at *16.)   

In a throw-away paragraph at the end of the opinion, the majority states that although it considered the larger question of whether the Federal Circuit should defer to the trial court’s claim construction rulings, it had “decided not to address that issue at this time.”  (Id. at *20.)  Thus, claim construction remains a question of law, rather than fact. 

The two-judge dissent is absolutely scathing and certainly entertaining.  “Now more than ever I am convinced of the futility, indeed the absurdity, of this court’s persistence in adhering to the falsehood that claim construction is a matter of law devoid of any factual component.  Because any attempt to fashion a coherent standard under this regime is pointless, as illustrated by our many failed attempts to do so, I dissent.”  (Id. at *22.)   

The dissent severely chastises the majority:  “Again today we vainly attempt to establish standards by which this court will interpret claims.  But after proposing no fewer than seven questions, receiving more than 30 amici curiae briefs, and whipping the bar into a frenzy of expectation, we say nothing new, but merely restate what has become the practice over the last ten years – that we will decide cases according to whatever mode or method results in the outcome we desire, or at least allows us a seemingly plausible way out of the case.”  The dissent ends with:  “The court’s opinion today is akin to rearranging the deck chairs on the Titanic – the orchestra is playing as if nothing is amiss, but the ship is still heading for Davey Jones’ locker.”

The Safe Harbor For Patent Infringement Is Broader – But Is The Result Better

By Pam Bertani

   

Approximately two months ago the United States Supreme Court decided the controversial case of Merck v. Integra Lifesciences I, Ltd., 125 S.Ct. 2372 (June 13, 2005).  The case surfaced concerns among patent owners, and all serious players in the multi-billion dollar pharmaceutical industry, specifically those using patented compounds to develop their own drugs.  As one commentator aptly framed the issue – the question before the Court was how much patent infringement does the safe harbor allow?

Recall that 35 U.S.C. § 271(e)(1) is the so-called Food and Drug Administration (“FDA”) exemption to patent infringement and provides, in pertinent part, that making, using, offering to sell, selling or importing a patented invention is not an act of infringement if such activities are performed “solely for uses reasonably related to the development and submission of information under a Federal law which regulates the manufacture, use, or sale of drugs or veterinary biological products.”  Under the Federal Food, Drug and Cosmetic Act (“FDCA”), a drug maker must submit research data to the FDA at two general stages of new drug development.  First, a drug maker must obtain authorization to conduct clinical trials (human tests) by submitting an investigational new drug application (“IND”).  The IND must describe “preclinical tests”, including animal tests, of the drug sufficient to justify the proposed clinical testing.  Second, in order to obtain authorization for new drug marketing, a drug maker must submit a new drug application (“NDA”), containing full investigational reports that demonstrate whether the drug is safe and efficacious.  Pursuant to FDA regulations, the NDA must include all clinical studies, as well as preclinical studies related to a drug’s efficacy, toxicity and pharmacological properties.   Generic drug makers may file an abbreviated new drug application (“ANDA”) by which the generic drug sponsor is not required to demonstrate safety and efficacy independently, either in pre-clinical or clinical studies. Rather, the ANDA requires only that generic drug makers show that the generic drug includes the same active ingredients as the original drug, and is biologically equivalent thereto. 

The pivotal issue in Integra was that the pre-clinical experimental drug testing at issue was not performed to supply information for submission to the FDA, but instead was performed to identify the best drug candidate that Merck would subject to future clinical testing under FDA procedure.  The Federal Circuit affirmed the Southern District of California’s interpretation of the exemption to cover clinical trials – but, to exclude pre-clinical trial experiments that were performed to identify potentially new drugs.  The Federal Circuit held that the pre-clinical trial experiments at issue were not exempt from infringement under § 271(e)(1) because the tests were not performed for the sole purpose of providing information to the FDA – but conversely for the commercial purpose of identifying potentially new drugs for Merck.

In a sweeping decision authored by Justice Scalia, the Supreme Court completely vacated and remanded the Federal Circuit’s decision, and thereby significantly broadened the Section 271(e)(1) safe harbor from infringement, which many believed to overbroad to begin with.  The Court read Section 271(e)(1) to provide a “wide berth for the use of patented drugs in activities related to the federal regulatory process”, and deemed apparent from the statutory text that Section 271’s exemption from infringement “extends to all uses of patented inventions that are reasonably related to the development and submission of any information under the FDCA.”  According to the Court:

         

       

  There is simply no room in the statute for excluding certain information from the

exemption on the basis of the phase of research in which it is developed or the particular submission in which it could be included. 

The Court refused to construe Section 271’s safe harbor provision so narrowly as to render illusory its protection for activities leading to FDA drug approval.  Properly construed, said the Court, Section 271(e)(1) “leaves adequate space for experimentation and failure on the road to regulatory approval”, at least where a drug maker has a reasonable basis for believing that a patented compound may work through a particular biological process to produce a particular physiological result, and uses the patented compound in research that – if successful – would be appropriate to include in an FDA submission.

The Federal Circuit’s safe harbor restriction, excluding preclinical trials from the scope of statutory protection, sent a chill through the pharmaceutical industry and beyond.  Fear centered on the prospect that the Federal Circuit’s decision was a major step back, and could potentially block drug makers from conducting pre-clinical research necessary to achieve FDA approval.  For instance, animal research is often a prerequisite for obtaining the green light to proceed to human clinical testing, and ultimate FDA approval.  Some reasonably feared that the Federal Circuit’s opinion could have been construed to leave drug makers liable for conducting such early stage research, which worried the industry in a major way.  The Supreme Court’s wholesale reversal of the Federal Circuit should allay a majority of such concerns.  But is society better off with broader safe harbor protections from infringement?  Obviously, industry says yes because theoretically now more drugs will move through the research, development and regulatory processes more quickly, which will facilitate bringing useful and effective pharmaceuticals to people who need them desperately. 

On the flip-side however, major research institutions would likely disagree, and contend that with eroded patent rights comes an innovative erosion and diminished incentive to continue developing new technology.  The Regents of the University of California, The American Council of Education, Boston University, Research Corporation Technologies, The Salk Institute for Biological Studies, the University of Alberta and the University of Oklahoma filed an interesting Amicus Curiae brief in support of Integra, which raised several key issues to consider.  The Amici identified their interests in managing, developing, licensing and enforcing university-related intellectual property, which forms a substantial part of the new drug discovery pipeline.  They contended that these institutions, along with various biotechnology companies, perform the often risky experiments that can lead to cutting-edge research tools, which ultimately permit technological progress.  According to the Amici, the university sector’s ability to patent technology arising from its research efforts is the alleged basis for transferring such technology to the public for public use and benefit.  Thus, to expand the Section 271(e)(1) safe harbor beyond the limits set forth in the statute’s plain meaning, as interpreted by the Federal Circuit below, will adversely effect the research community as a whole, and the university research community in particular.  In this regard, the Amici expressly state that given the normal expectation that innovation follows invention, an erosion of patent rights corresponding to safe harbor expansion would bring with it a lag in innovation.  Without the protection afforded by viable patents, there would be a lessened interest within the private sector to support university-related research functions.

With such polarized and divergent views on how to achieve the highest public good with respect to technology and innovation, the most likely result is that each side of the issue will find a workable middle ground and continue to build on what has become a phenomenal knowledge base in America and abroad.  A textbook “win-win” situation is surely on the horizon.

Early Stage Companies and Strategic Business Alliances

By: R. Todd Wilson

Early stage companies often hope to gain significant operational advantage by forming strategic alliances.  Such alliances may significantly accelerate the growth of such companies.  By collaborating to achieve mutual commercialization or implementation goals, the entities that form such alliances seek to maximize the value of each entity’s intellectual property in ways that, without such collaboration, would not be individually possible.

Key to the success of alliances is that they are designed not only to complete the transaction in which they are created but to ensure that the resulting relationship accomplishes the technology commercialization or implementation goals of the partners entering into the alliance.  If structured correctly, strategic alliances can reduce the time, cost and risk of launching new products. Additionally, alliances often allow a quicker means of developing new technologies and accessing new markets.  On the other hand, if the strategic alliance deal structure is flawed and expectations of the partners are not aligned, the relationship will falter and the expected advantages of the alliance will not likely be achieved.

Strategic alliances are arrangements between two or more entities to achieve certain goals.  Such alliances, in their simplest forms, may include license agreements, marketing agreements, and development agreements.  More complex alliances include equity investments, joint ventures, acquisitions and mergers. 

In each business and technology alliance, there are often complex legal and business challenges. The need to identify, protect, procure, transfer, develop and/or commercialize intellectual property is one of the most important, but often the most difficult and contentious, aspects of alliance negotiations and implementation. Equally important is the need to identify and implement the appropriate structure for the business which is the subject of the alliance.

The simplest of strategic alliances include contractual arrangements between parties which are generally short-term arrangements with specified responsibilities and goals. Contractual-based alliances take many forms including those for intellectual licensing, product development, OEM agreements, product marketing and services arrangements. In such simple alliances, a formal management structure is often not required. The contract governing such an alliance, however, should include pertinent aspects of the relationship such as (1) confidentiality, (2) ownership of pre-existing intellectual property and intellectual property developed by the alliance, (3) scope of work and responsibilities of the parties, (4) milestones for development and/or commercialization of technology, (5) logistics and financial terms, and (6) term, termination, and assignment of interests.

Equity investments are another means of forming alliances between early stage companies and strategic commercial partners. A minority equity investment may be accompanied by a contractual agreement between parties such as a technology licensing, OEM, or distribution agreement. The commercial partner may wish to form this type of alliance in order to gain a competitive advantage through access to the early stage company’s technology and to take part in that company’s financial success through equity ownership. The early stage company may seek the validation of its technology and business model as well as access to capital that the commercial partner affords. The early stage company should consider carefully the potential loss of operational control and independence that such an alliance presents, however.  Additionally, regardless of the equity investment, any sudden change of direction by the commercial partner regarding contractual agreements between the parties could have a significant financial impact on the development stage company.

Joint ventures involve creating a separate legal entity such as a corporation, limited liability company or partnership through which the alliance partners conduct business. Joint ventures are typically created when a long-term alliance between partners and a separate management structure is intended. The parties to a joint venture might expect that the newly formed entity will, in time, be able to function entirely independently of the original parties. Joint ventures are created to combine complementary technologies and products, to develop or expand marketing and distribution expertise, to share technical or professional experts, to share economic risk, and to increase financial support or share economic risk. Considerations in forming a joint venture should include intellectual property rights of the joint venture as well as the forming parties, revenue sharing, governance and management, dispute resolution and exit strategies. Also to be considered are the commercialization-focused aspects of the alliance including product development, production, distribution and sales.

Mergers and acquisitions are a more permanent means of aligning two previously independent business entities. The parties to a merger or acquisition may agree to such a business combination to (1) acquire technology or to complement or replace a current technology, (2) to acquire complementary products to broaden an existing product line, (3) to acquire new or complementary markets and channels of distribution, and (4) to acquire resources and to benefit from the economies of scale that such additional resources afford. An early stage company may gain a considerable leg-up in its commercialization and marketing efforts by merging with a more formidable partner while an acquiring company may gain considerable technical and intellectual property resources which might not otherwise be available. Important considerations for both parties in conducting their due-diligence investigations relative to such a business combination include evaluation of intellectual property and technology assets, review of pertinent licenses and other contractual arrangements, and review of financial information.

Each form of strategic business alliance offers particular opportunities for early stage companies. The growth of early stage companies may be significantly accelerated through strategic alliances in each of the various forms. Additionally, even the relatively simple forms of alliances such as contractual and licensing arrangements can turn out to be the first step toward equity investments in or acquisition of the early stage company.

Early stage companies must also be aware, however, of the potential risks presented by strategic alliances. For example, early stage companies may lose considerable independence and operational control as a result of an alliance with a financially powerful partner. An early stage company also potentially loses its ability to control the confidentiality of proprietary information and trade secrets. Additionally, an early stage company often finds itself unable to take advantage of future business opportunities with other firms that compete with an alliance partner.

Finally, a host of other considerations face early stage companies with regard to strategic alliances. In addition to the business and intellectual property considerations involved in each type of collaboration between an early stage company and a potential partner, the parties must consider the competitive, logistical, tax, antitrust, and accounting issues surrounding each type of strategic business alliance. The parties must also determine the appropriate management style for the alliance and how to avoid potential culture clashes between the aligned parties.

Grokster May Be Held Liable

The United States Supreme Court held on Monday that Internet file-sharing services will be liable for copyright infringement if they intend for their customers to use their software primarily to engage in illegal downloading.

Read the full opinion here:  Download grokst1.pdf

Just Say Yes! Supreme Court Ruling May Expand Availability and Variety of Drugs

By Adam Jones

In a case that will dramatically impact both the pharmaceutical and biotech industries, the U.S. Supreme Court recently expanded the ability of researchers to experiment with patented drugs without being held liable for patent infringement.  In a unanimous ruling, the Court held that the use of patented compounds in preclinical studies is protected under the current “safe harbor” law allowing experimental use of patented compounds, as long as there is a reasonable basis for believing that the experiments will produce information relevant to filing for FDA approval.  The case, Merck KGaA v. Integra LifeSciences, was a clear victory for pharmaceutical researchers and may have the effect of speeding the development and delivery to the market of new and generic drugs, however, some biotech companies worry that the case could put them out of business.

The dispute in the case began over Integra’s ownership of patents related to short amino acid sequences, called RGD peptides, which play an important role in many biological functions.  Merck had been funding anti-cancer research looking for drug candidates that would inhibit angiogenesis, the process by which new blood vessels sprout from existing blood vessels.  Angiogenesis plays a critical role in the development and nourishment of tumors.  When Merck proceeded to make use of Integra’s patented RGD peptides in its drug research without obtaining a license from Integra, Integra sued for infringement. 

It is usually an act of patent infringement to make, use, offer to sell, or sell any patented invention, including pharmaceutical drugs and compounds.  However, in 1984 Congress created a “safe harbor” from patent infringement for certain activities related to drug research.  The purpose of this safe harbor, found in the Hatch Waxman Act of 1984, was to encourage the speedy delivery to market of generic drugs by allowing researchers to use whatever tools were available to them, without fear of liability for patent infringement.  Before enactment of the safe harbor, pharmaceutical companies owning a patent on a compound or drug could bar competitors from using the patented compound or drug for any purpose, including research, thus effectively stalling the development of potentially useful drugs by competitors until the term of the patent expired.

Merck claimed that its angiogenesis research was protected under the safe harbor.  Integra argued that the safe harbor did not apply to Merck because not all of Merck’s experiments using the patented compounds resulted in submission to the FDA of a product for regulatory approval.  The lower courts agreed with Integra, adopting a narrow view of the safe harbor protection, and essentially limiting the use of patented compounds to clinical trials, the final stages of drug research, rather than early-stage experiments that could determine which of several compounds would make a good drug candidate.  This interpretation of the safe harbor clause severely limited the research abilities of pharmaceutical companies.  Integra was awarded $15 million in damages based on patent infringement in a jury trial in the U.S. District Court in San Diego.  The Federal Circuit Court upheld Merck’s liability for patent infringement, and the Merck appealed to the Supreme Court.

After reviewing the case, the Supreme Court took a broad view of the safe harbor clause, finding that Congress intended to “leave adequate space for experimentation and failure on the road to regulatory approval.”  The Court interpreted the safe harbor to exempt from infringement “all uses of patented compounds ‘reasonably related’ to the process of developing for submission under any federal law regulating the manufacture, use, or distribution of drugs.”  The decision makes clear that the safe harbor for using patented compounds applies to a wide variety of medical and pharmaceutical research, not solely to research that will yield an FDA-approved drug.  Researchers must only have a reasonable basis for believing that a patented compound may be useful in creating a new drug for submission to the FDA for approval. 

The decision allows researchers much greater freedom to experiment with patented compounds in an effort to create new and useful drugs.  One of the major benefits to patients that may come of the Court’s ruling, though, may be in the increased availability of generic drugs.  The expanded scope of the safe harbor clause, will now allow pharmaceutical companies to more quickly obtain FDA approval for generic counterparts to brand-name drugs, and introduce the generic drugs to the market as soon as possible after expiration of the brand-name drug’s patent.  Without a broad interpretation of the safe harbor clause, pharmaceutical companies would have to wait to perform research on patented drugs until the 20-year patent term had expired.  It typically takes many years to perform the experiments required to obtain FDA approval, and now pharmaceutical companies can begin the process of developing generic and competing drugs before the patents of the original drugs have expired.  The result is that companies are able to bring generic and competing drugs to market as soon as possible after the expiration of the relevant patents, rather than being delayed for up to a decade while maneuvering through the experimentation and FDA approval stages.

Not everyone is happy with the Supreme Court’s recent decision, though.  Many biotech companies produce patented compounds and products used in drug research.  The broad interpretation of the safe harbor clause could deprive them of valuable licensing revenue, and effectively put them out of business.  Also, universities that rely on licensing money from patents they hold for research techniques could be adversely affected.  The owners of existing drug patents that will now be freely available for use in research by their competitors argue that they spent substantial time and money to develop and market the patented drugs, and now their competitors will have an unfair head start in bringing competing drugs to market. 

Patent law was established to provide a reward for innovation by granting its owner a limited monopoly on the patented invention, and some feel as though the expanded view of the safe harbor clause undercuts the reward function of patented drugs, and may in fact reduce the incentive to create new drugs based on compounds other than those already patented.  We continue to struggle to find a balance between rewarding innovation and making products freely available to the public.  Nowhere is this balance more difficult to achieve than in the pharmaceutical industry, where humanitarian concerns play an important role, and innovation is key to survival.

High Tech Company Formation Requires Careful Consideration

By Julie Garcia

Determining the choice of entity for a high technology company can be a daunting task. In general, careful consideration should be given to the choice of entity when forming any type of company; however, high technology companies have additional issues that may alter the decision regarding the choice of entity. Generally, raising capital to fund the research, development and manufacturing of the company’s products may determine the type of entity best suited to the needs of the new company. Typically, the type of entity will be either a corporation or a limited liability company. If a corporation is chosen, the decision as to whether the corporation will be a Subchapter S Corporation will also need to be made. Partnerships and sole proprietorships are not commonly chosen as the type of entity for high technology companies primarily due to liability concerns. Corporations and limited liability companies each have pros and cons that must be carefully considered for each situation when determining the type of entity.

Corporations have been in existence for a long time and generally have a well established base of both statutory and case law guidance. Although each jurisdiction may have different rules, regulations and cases that govern corporations and some jurisdictions may be more favorable to corporations than other jurisdictions, general corporate principles exist that can be examined when determining the type of entity to use for a new venture. If a corporation is chosen, the jurisdiction for formation should be carefully analyzed to determine the most advantageous jurisdiction. Many businesses prefer corporations because of the long standing history and general feeling of comfort regarding issues that are important to the founders of a business, such as liability protection and corporate governance. Financing a corporation is a path that has been well trodden and individual strategy based on the company’s circumstances and business plan becomes the focus of financial planning. If a high technology company plans on funding its operations through venture capital, formation of a corporation is generally preferable to other types of entities due to general familiarity with the corporate structure and a long history of investments into corporations by venture capitalists, angel investors and institutional investors.

A Subchapter S Corporation, generally referred to as an S Corporation, is a variation on the corporate entity. An S Corporation provides the same general protections as a corporation and is subject to the same corporate governance rules and regulations as a corporation; however, S Corporations generally provide a tax benefit to the company. An S Corporation is subject to limitations on the number and type of eligible shareholders. An S Corporation is limited to 75 shareholders (subject to specified counting considerations, for example, husband and wife) and, in general, only individuals and not entities are allowed to be shareholders of an S corporation. In addition, shareholders cannot be nonresident aliens. There are a few exceptions to the rule denying entities as shareholders, however, the exceptions generally relate to trusts formed for estate planning purposes controlled by a shareholder. Another corporation is generally not allowed to be a shareholder of an S Corporation which may create an issue if the funding of the company depends on institutional investors or venture capitalists. Most high technology companies obtain financing from venture capital funds, institutional investors or angel investors which are generally formed as entities that are not allowed to be shareholders of an S Corporation. Although an S Corporation is generally favored by high technology companies that will be funded by the founders, a high technology company that plans on obtaining significant funding from external sources will generally not be eligible to become an S Corporation.

A limited liability company is a newer type of entity, as compared to corporations, that has gained wide acceptance and is the preferred choice of entity in certain industries and/or transactions. A limited liability company provides a lot of the same general protections as a corporation, and although an analogy can generally be made to the rules, regulations and case law governing corporations, significant areas of limited liability company rules and regulations have not yet been tested in the courts. Although capital can be raised for a limited liability company, the general structure of a limited liability company may impose an administrative burden if a significant number of investors are projected. Although a limited liability company operating agreement may allow for different classes of membership interests and ultimately may allow for more creativity in structuring the investment transaction, the lack of court and statutory guidance on a number of issues deter many smaller high technology companies from choosing the limited liability company structure.

High technology companies face a number of issues that a traditional company may not face due to concerns with its intellectual property protection and concerns relating to financing of the company. The traditional model for a high technology company seeking funding from venture capitalists or institutional investors is generally to form as a corporation and sell stock to raise capital. Although corporations may have different classes of stock and become complicated, the general nature of corporate governance may be more structured than a limited liability company and provide a better framework to handle a large number of investors. Although an S Corporation may be preferable, particularly from a tax perspective, it may not be a viable option if the company intends to seek investments from venture capitalists or institutional investors formed as entities to fund its research, development and product launch. A limited liability company, although preferable in a number of industries, may impose limitations on a high technology company that become burdensome and outweigh the tax advantages as the choice of entity. Careful consideration to the business plan, future financing needs and general operating structure of a new business venture should be made prior to the formation of a high technology company.

The PB & J Patent

By Audrey Millemann

            The “peanut butter and jelly sandwich patent” has been a hot topic lately, from television news broadcasters to intellectual property commentators.  The triggering event was a Wall Street Journal article on April 5, 2005 concerning a hearing to be held that day by the Federal Circuit Court of Appeals.  The case was an appeal by the J. M. Smucker Company of an earlier decision by the Board of Patent Appeals and Interferences.  The Board had upheld the Patent and Trademark Office examiner’s rejection on obviousness grounds of two patent applications filed by Smucker’s for its crustless peanut butter and jelly sandwich (sold as the “Uncrustable”), a product that apparently generated $27.5 million in sales in 2004.

            One of the claims at issue in these applications states:

            “A method of creating a hermetically sealed crustless sandwich, said method comprising:

            (a)        providing a first slices of bread with an edge crust;

            (b)        applying a layer of peanut butter onto said first slice in an area inside said crust and defining a substance free outer periphery of said first slice;

            (c)        applying a layer of fruit spread over said peanut butter layer leaving a perimeter of uncovered peanut butter;

            (d)        covering said layer of fruit spread by a second layer of peanut butter contacting said first layer of peanut butter to encapsulate said fruit spread;

            (e)        applying a second slice of bread over said first slice of bread with an edge crust matching said the edge crust of said first slice;

            (f)         providing a cutter with a continuous cutting edge having a desired cut shape larger than said periphery;

            (g)        positively forcing said cutting edge through said slices in unison with said cut shape outside said area to cut two matching cut portions of bread with an outer periphery outside side area and a contour matching said cut shape and surrounding said area;

            (h)        compressing said bread completely around said outer periphery to seal said bread around said contour with said peanut butter and encapsulated first spread captured between said bread portions, wherein said compressing operation also crimps said substance free periphery at spaced pressure points to give space locations of greater sealing force at said outer periphery of said bread portions; and,

            (i)         placing said crustless sandwich into an airtight package for long term storage.”

            The key issue before the Board was whether Smucker’s method of crimping the edge of the Uncrustable sandwich was unique.  The Board had adopted the examiner’s reasoning, finding that Smucker’s claims were obvious based on existing methods used to make ravioli and pie crust.  The Board cited prior art including an international tart cookbook and related device and a newspaper article telling parents how to make peanut butter and jelly sandwiches that didn’t get soggy in school children’s lunch boxes.  The Board was not persuaded by the commercial success of the Uncrustable product, stating that there was no “nexus between the claimed invention and the evidence of commercial success.”  The Board affirmed the examiner’s rejection.  2003 WL 23507730 (Dec. 10, 2003).

            On appeal to the Federal Circuit, Smucker’s argued that the prior art disclosed a “smashed edge,” not a “surface-to-surface-seal” as was used in Smucker’s method.  According to Smucker’s, the prior art was “the antithesis” of Smucker’s method; Smucker’s method preserved the integrity of the two separate slices of bread at the edge while the prior art method crushed the edge into one mass. 

            Things did not go well for Smucker’s at the Court of Appeals hearing.  One judge stated that he and his wife had used a crimping method when making peanut butter and jelly sandwiches for their child (presumably many years before Smucker’s patent application was filed).  Two days later, on April 8, 2005, the Court of Appeals affirmed the Board’s decision without an opinion.  In re Kretchman, Case No. 04-144849 (Fed. Cir. April 8, 2005). 

            This is not the first venture of Smucker’s into the world of patenting peanut butter and jelly sandwiches.  The original Uncrustable product was developed in 1995 by two dads in the Midwest who filed a patent application in 1997 and were selling the sandwiches to schools.  Smucker’s bought the dads’ business, and on December 21, 1999, the patent issued as United States patent no. 6,004,596.  The two patent applications before the Federal Circuit were continuations of continuations of the ‘596 patent.

            Smucker’s takes the peanut butter and jelly sandwich business very seriously.  In 2001, it filed a patent infringement suit against a Michigan grocery/catering business, Albie’s Foods, alleging that Albie’s crustless peanut butter and jelly sandwiches infringed the ‘596 patent.  That case was eventually dismissed, but the ‘596 patent is now under reexamination. 

            As happened a few years back with Amazon.com’s “one-click” business  method patent, Smucker’s peanut butter and jelly sandwich patent has caused a flurry of criticism of the United States patent system and (yet another) demand for patent reform.  These critics argue that the patent system must be broken because it resulted in the ‘596 patent being allowed.  They believe that it is too easy to get a patent allowed and too difficult to invalidate a patent, all of which stifles competition.  They also feel that the costs of obtaining a patent and enforcing it in litigation (or defending against a bogus patent infringement claim) are too high. 

            All of this is well and good, but, at least at this time, with respect to Smucker’s two pending applications, the patent system appears to be working.  When the decision in the reexamination is made, we will know for sure.

Will Complex Licensing Requirements Silence Independent Podcasting?

By Scott Hervey

Podcasting is a way of publishing sound files to the Internet, and delivering the files to users who subscribe to a feed.  Podcasting uses a distinct content delivery protocal that has enabled many producers to create self-published “radio shows” that users can subscribe to and have delivered directly to their computer via one of a number of content aggregators. 

Podcasts are technologically unlike webcasting or streaming. Webcasting is an Internet stream of a live broadcast, or an online simulcast of a broadcast signal.  Streaming is a technological means for accessing a stream of electronic information at the same time it is delivered to a user’s computer.  Neither webcasting nor streaming result in the creation of an audio file on the Internet user’s computer.  Podcasting however, involves the downloading of a single complete audio file to a user’s computer to be listened to at a later time.

Like blogs, podcasting has been adopted both by amatures who want to host their own “radio show” and by professionals who see podcasting as an inexpensive way to distribute content.  Podcasting is not the realm of techno geeks or Internet extremists.  Mainstream broadcasting and media companies have realized the benefit of podcasting.  National Public Radio offers podcasts of most of its shows, and Infinity broadcasting network announced plans to launch a pure podcast radio station.  ABC is even offering podcasts of Nightline and Good Morning America.  Despite Corporate America quickly embracing this new technology, the majority of podcasts being offered today are from individuals and small businesses.

One of the quickest ways for a podcaster to get into hot water is to infringe a third party’s copyright.   A number of music podcasts are produced by DJ’s or independent record labels that use their podcast programs as a means of promoting other artists.  Most of these podcasts have a “mixed tape” quality to them, especially in the dance, hip-hop and rap genres.  Other podcasts are produced by music fans who may be interested in a certain style or type of music.  For example, one more popular podcast, Coverville, focuses entirely on covers songs.  If a podcast includes music and the podcaster has not obtained all the necessary rights, copyright infringement will result.  The real problem is for podcasters who want to stay out of the RIAA’s crosshairs, determining exactly what type of license to get can be challenging.

Copyright law implications in music can become very confusing, very quickly.  Copyright law provides the copyright owner with the following rights:  the right to control the public performance of its copyrighted work; the right to control the production and distribution of a sound recording embodying a copyrighted work; and the right to create a copy of a sound recording.  Each of these rights may be implicated in podcasting. 

Performance right organizations (PRO), such as BMI, ASCAP and SESAC license the public performance of copyrighted work.  Usually a license from all three is recommended because each organization represents different publishers of musical works.   Performance rights organizations have staked a claim to the right to license music for podcasting.  On its website, BMI claims that it has “been licensing podcasters for nearly a year covering the public performance rights to the BMI repertoire” and lists Coverville as one of its licensees.

The right to produce and distribute a sound recording which embodies a copyrighted composition is controlled by music publishers, who have abdicated the responsibility to the Harry Fox Agency.  HFA collects mechanical license fees (a mechanical license covers the right to reproduce and distribute copyrighted musical compositions [i.e. songs], including uses on CDs, records, tapes, and certain digital configurations) on behalf of publishers.  This includes full permanent downloads, whether or not charged for.  Since podcasting technology results in the creation of a single digital audio file to a user’s computer, HFA could rightfully claim that it is the proper agency to control licensing for podcasts.  While HFA has yet to make this claim, given what occurred when PROs and HFA were trying to determine who controlled the right to issue licenses for webcasting and streaming, it is only a matter of time.

It is important to note that HFA licenses cover the right to make and distribute recordings of musical compositions, and not the use of existing sound recordings.  In order to clear those rights, a podcaster would have to obtain permission from the owners of each sound recording, which in most cases are record labels. 

In 1995 and again in 1999, the Copyright Act was amended to create a statutory license mechanism for the digital transmission of sound recordings and musical works.  The 1995 legislation covered uses like the commercial sale of MP3s, while the 1999 amendment covered webcasting and streaming.  The 1999 amendments allowed webcasters the right to webcast or stream copyrighted music, and required them to pay certain pre-set royalties to SoundExchange, a performance rights organization that was designated by the U.S. Copyright Office to collect and distribute statutory royalties. 

The 1999 amendments to the Copyright Act do not provide coverage for podcasting because the statutory license only covers the transmission of a sound recording, not the distribution of a copy of it.  Podcasting involves the reproduction of a sound recording and results in the creation of an audio file on a user’s computer.  As stated above, clearing the right to create a reproduction of a sound recording, not just the musical composition, necessitates approval from the record label that owns the sound recording. 

Although BMI and ASCAP are offering performance licenses, podcasters who want to remain on the right side of the law may also need to clear rights from other parties.  Because there is no industry wide standard and no central clearance mechanism like SoundExchange, clearing rights to the sound recording can be rather expensive and time consuming.  The music industry and our lawmakers need to devise a mechanism that allows podcasters to easily comply with the law and a licensing scheme that is not financially daunting.  Most non-corporate podcasters, such as Coverville, fund their operation entirely out of their own pocket, or by donations from listeners.  There is a desire for this type of alternative music programming; a desire that is not being fulfilled by commercial radio.  It would be shame if red tape and licensing costs silenced these unique and interesting programs emanating from the left of the radio dial.

Viva la MP3

By Scott Hervey

Wired reports that the French judiciary has been issuing lenient sentences and penalties to individuals involved in criminal proceedings involving illegal file trading.  The president of the French magistrate union, Judge Dominique Barella, has openly taken the position that the harsh criminal penalties imposed under French copyright law are inappropriate under the circumstances.  Wired reports  the Barella has insisted that a more appropriate policy needs to be adopted in France and in Europe that protects what he says are mostly young people of the MP3 generation who are weak targets against the machinations of the entertainment industry's legal agenda.

The French entertainment industry is not taking Barella's position lightly.  In a letter to the French Minister of Justice, representatives of France's entertainment, film, music associations stated "[w]e are surprised and shocked that the president of the magistrates union, given the level of influence he has on his colleagues, can publish in the press a call to not criminally sanction criminal acts, which contradicts the intentions of government bodies."

Barella defends his position, stating that the government's resources would be better spent focusing on large scale, international counterfeiting rings instead of targeting young Parisians who just want fill their ipod.