Troy & Schwartz Attorneys-At-Law

On April 5th, a federal judge in the U.S. District Court of Virginia heard summary judgment arguments on this very issue in Thaler v. Iancu.  Thaler brought this action to challenge the current legal definition of inventorship of patent applications after the United States Patent & Trademark Office had rejected two of his patent applications for failing to identify a person as inventor in non-compliance with the Patent Statute’s statutory requirements.  Instead, he had named an artificial intelligence (AI)-based system, DABUS, as the inventor and disavowed any notion of being named a sole or at least a joint inventor.  Thaler may well have brought as a test case given AI’s increasing role in R&D in industries ranging from the life sciences to chemistry to engineering.

The judge is expected to rule in favor of the USPTO on the basis of the patent statute’s definition of inventor which states:  “The term “inventor” means the individual or, if a joint invention, the individuals collectively who invented or discovered the subject matter of the invention.”  Any change in the definition of inventor to include AI will require intervention by Congress.

The issue is not, however, as simple as expanding the definition to include the AI.  For example, an Inventor must contribute to the conception of the invention.  As the Manual for the Procedure for Examining Patents (MPEP) states, “[t]he threshold question in determining inventorship is who conceived the invention.  Unless a person contributes to the conception of the invention, he is not an inventor.”  MPEP § 2019.

In understanding the legal definition of inventorship, it is important to understand that the inventor is not required to reduce the invention to practice.  “Difficulties arise in separating members of a team effort, where each member of the team has contributed something, into those members that actually contributed to the conception of the invention, such as the physical structure or operative steps, from those members that merely acted under the direction and supervision of the conceivers.”  MPEP § 2019 citing a 1991 case from the Board of Patent Appeals and Interferences.

Can AI spontaneously conceive of an invention without any human input or is it actually being directed to reduce a human-inputted concept to practice?  Under this scenario, AI cannot be an inventor even if the definition for inventor is expanded to include AI.

Additionally, assignment of patent rights is a common practice.  Generally, any scientist or engineer employed by a company is required to execute and assignment of any patent rights resulting from his or her endeavors to the company-employer.  The company generally files the patent application as the assignee wherein the inventors must always be named.  Another common patent assignment scenario is one where the inventor, as the patent owner, assigns another person, often a business entity, to commercialize the patent.   Patent licensing is another common business transaction surrounding issued patents.   These routine contractual business transactions will clearly become complicated if AI is allowed to be named as an inventor.  Why? Because the party to an agreement must have the requisite intent to enter into the agreement.   Can AI have that requisite invent to assign its patent rights or enter into a licensing agreement?

Other considerations include:  1) An AI machine’s ability to have standing to sue or be able to testify as the inventor in a patent infringement lawsuit; 2) Ownership rights in any resulting patentable invention if the AI machine was designed by an independent person and purchased by the inventor.  Here, any purchase contracts should unequivocally state that any resulting patentable technology resulting from the usage of the AI machine belongs to the purchaser of that machine.  But what if the AI machine is named as the inventor?  The point is that any such contracts involving AI must be carefully tailored to anticipate possible scenarios.

This commentator is not in favor of having AI named as an inventor perhaps because of a bias in favor of the human brain as the ultimate source of creativity and ingenuity.  Instead, Congress should first address the upheaval in intellectual property law caused by simply bad court decisions in U.S. patent law concerning patent eligibility under § 101 and just this month, the questionable application of the fair use doctrine in a copyright law case.  Click here for a link to the blog on the copyright case.  There is also no question that human ingenuity is what created AI in the first place and that AI is here to stay.

As an alternative to complicating the patent law business transactions that are so essential to acquiring investment funding and commercially exploiting patented inventions, a separate statute for thoughtfully addressing the unique aspects of AI-involved inventions is suggested.  This suggestion of a separate patent classification has precedent through plant patents and design patents – types of patents that are separate and distinct from utility patent applications, the very type of patent application at issue in the Thayer case.

THANK YOU FOR YOUR INTEREST IN THIS BLOG.  AS USUAL THE CONTENT IS FOR INFORMATIONAL PURPOSES ONLY AND IS NOT LEGAL ADVICE.

Intellectual property law is a complex area of the law.  Contact us at 305-279-4740 for a complimentary consultation on protecting your inventions, creative works, brands, and proprietary information through patents, copyrights, trademarks and trade secrets or our litigation services involving intellectual property disputes.   We represent both individuals and business entities.  Our mission is to serve innovators and creators in protecting the fruits of their hard work and ingenuity through our Client Services Creed:  Conscientious, Rigorous, Energic, Empathetic, and Diligent legal services. 

© 2021 by Troy & Schwartz, LLC

Posted by Susan Dierenfeldt-Troy, Esq.

Troy & Schwartz, LLC

Where Legal Meets Entrepreneurship™

Intellectual property assets may comprise as much as 70% of an average company’s value according to the Harvard Business Review.  Not surprisingly, businesses large and small are concerned about: 1) protecting their intellectual property from theft or infringement and potential creditors; and 2) reducing their income taxes as part of an overall IP asset management strategy.  Intellectual property holding companies (IPHCs) became a popular means through which companies sought to protect their IP assets and reduce taxes by establishing a wholly-owned subsidiary whose purpose was only to control and own IP assets such as patents, copyrights, trademarks, trade secrets, and other proprietary information in the 1990s.

The IPHC, established by the parent company, does not itself use the IP it owns (e.g., by manufacturing and distributing a patented product).   Instead, the holding company licenses its IP rights to affiliated operating companies that handle the day-to-day business activities but do not themselves own any of the IP assets.  The holding company as the licensor then receives royalties from its licensee(s).    For example, say ZYX, Inc. owns a U.S. patent for a product it manufactures and sells under a registered trademark.  It has decided to form a Delaware IPHC, CBA, Inc., for holding its patent and registered trademark.  CBA, Inc., now as the IPHC, licenses the patent and registered trademark to ZYC, Inc. in return for a two percent royalty on the patented and trademarked product’s sales.  For states such as Delaware which does not charge income tax on royalties, the tax savings can be substantial. Additionally, ZYX, Inc. can likely take the royalty payment as a tax expense write-off.

States eventually figured out that holding companies were costing them a lot of money and the majority of them have enacted different types of reporting requirements for IPHCs to recover tax monies:  a) mandatory combined reporting (requiring companies to file a single comprehensive tax return for all of their subsidiaries when they calculate their taxes); b) add back statues (requires companies to add back any tax deductions they have taken for royalties paid to their IPHC); and c) the economic nexus approach wherein courts are tasked with finding if an economic nexis (a/k/a/ the Geoffrey rule after a 1993 South Carolina case involving Geoffrey, Inc. as the IHPC for the Toys “R” Us trade name) exists.  As such, IPHCs are not used as much as they were over a decade as a tax “shelter.”  Delaware, however, still continues to be an IPHC tax haven.

What about Florida?  Florida does have a corporate income tax but remains one of a handful of “corporate income” tax states that hasn’t adopted an add-back or combined reporting statute to try and reclaim lost tax revenue attributable to Florida IPHCs.  Furthermore, Florida IPHC law is complicated by the fact that only mining companies, by statute, must count royalties when calculating their income taxes.  For an excellent discussion on the politics surrounding the issue of Florida IPHC taxation see Florida Tax Laws and Intellectual Property by Jason Garcia, Florida Trend Magazine.

Despite the fewer taxation benefits now afforded by most states to IPHCs, IPHCs can still offer IP asset-protection benefits, for example by allowing a company to quarantine its intellectual property from claims brought against the operating companies.  For instance, in the event the affiliated operating company is sued, the separation of IP assets from the affiliate to an IPHC may well protect that property from potential judgments in a lawsuit.

Any business entity, including an IPHC should be structured in a manner that best fits the business model.  All business entities, whether a C-Corp, S-Corp, or Limited Liability Company have their own considerations which should be discussed with in attorney knowledgeable in IP asset protection. Any such IP transfer needs to be in writing and is generally executed as an assignment of rights document.  The assignment of any issued patent and registered trademarks and copyrights should be recorded with the United States Patent and Trademark Office and/or the U.S. Copyright Office.

Anybody considering forming an IPHC should of course understand the taxation requirements of the state where the IPHC entity will be formed.  Additionally, any IPHC owner needs to understand that infringement actions involving the IP owned by an IPHC may result in unintended consequences for the unwary.  For example, whether or not a plaintiff has standing to sue is a threshold question in any lawsuit.  For a patent infringement action, only patent owners or exclusive licensees have standing to sue for infringement.  A typical exclusive licensing agreement may not be “exclusive” for patent infringement purposes. That is, absent a provision within the exclusive licensing agreement that the patent licensee has the right to sue, the exclusive licensee may be found to have no independent right to sue.

Why is this important to an IPHC?  Because the IPHC may be able to obtain an injunction as the patent owner, but will be limited in its ability to seek lost profits as damages.   For example, a patent-holding IPHC normally does not manufacture or sell a product itself.  The IPHC thus suffers no lost profits damages as a result of any infringement of its patent and any recovery will likely be limited to reasonable royalty damages which are generally substantially lower than lost profits.  Rite-Hite Corp. v. Kelly Co., 56 F.3d 1538, 1553 (Fed. Cir. 1995).

As for non-exclusive patent licenses, the IPHC cannot claim lost profits and will be limited to an award of reasonable royalty damages.  However, non-exclusive patent licenses may provide the IPHC with additional opportunities to exploit its IP beyond just one licensee.

In the context of trademark rights, the IPHC holding company must have sufficient quality control over the goods/services provided under the licensed trademarks.  Failure to exercise sufficient quality control may create what is known as “naked licensing”, resulting in potential cancellation of the registered marks.  Click here for a previous blog on the ramifications of naked licensing.

Take Home Points:

1. Before setting up an IPHC, understand the tax laws of the proposed entity-formation state by consulting with a knowledgeable CPA or tax attorney.
2. Before setting up an IPHC, determine the best type of business entity by consulting with a knowledgeable IP asset protection attorney.
3. Ensure that the assignment of IP assets to the IPHC is done via a formal assignment agreement.
4. Ensure that an exclusive patent licensing agreement includes appropriate provisions giving the exclusive licensee the right to sue for patent infringement. Utilize the services of a knowledgeable IP licensing attorney.
5. For trademark licensing, ensure that the licensing agreement includes appropriate provisions allowing the IPHC to monitor the quality and goodwill of the licensed marks. As with patent-licensing agreements, utilize the services of a knowledgeable IP licensing attorney.

THANK YOU FOR YOUR INTEREST IN THIS BLOG.  AS USUAL THE CONTENT IS FOR INFORMATIONAL PURPOSES ONLY AND IS NOT LEGAL ADVICE.

Call us for a complimentary consultation on IPHCs or IP-licensing or any of your IP legal needs at 305-279-4740.

May you and your loved ones stay safe & be well during these challenging times.

© 2020 by Troy & Schwartz, LLC

Attorneys often categorize themselves as either only transactional or only litigation attorneys. The fact is that legal documents, whether drafted by a transactional attorney specifically retained to draft an agreement or “grabbed off” the Internet, may become the subject matter” of a lawsuit, either directly as in a breach of contract claim or indirectly as where an agreement fails to properly address statutory requirements pertinent to the contact.   The latter situation is discussed in the Federal Circuit Court of Appeal’s Feb. 19, 2020 decision in Arctic Cat, Inc., v. Bombardier Recreational Products, Inc.

Arctic Cat is the owner of two patents directed towards thrust steering systems for personal watercraft (“PWCs”). Although it initially sold the inventions before the patents had issued, Arctic Cat later entered into a license agreement with Honda for several patents including the PWC patents.  Somewhere along the licensing negotiating process, the provision requiring Honda, as the licensee, to mark all licensed patented products with the applicable patent numbers was deleted.  The final version even expressly stated that Honda had no marking obligations.  This provision was contrary to the requirements of 35 U.S.C. § 287 and case law involving the interpretation of that statute.

Section 287(a) provides in pertinent part:

Patentees, and persons making, offering for sale, or selling within the United States any patented article for or under them, or importing any patented article into United States, may give notice to the public that the same is patented . . . by fixing thereon the word “patent” . . . . In the event of failure so to mark, no damages shall be recovered by the patentee in any action for infringement, except on proof that the infringer was notified of the infringement and continued to infringe thereafter, in which event damages may be recovered only for infringement occurring after such notice. Filing of an action for infringement shall constitute such notice.

The notice provision of § 287 does not apply to patents directed to processes or methods. Nor does it apply if a patentee never makes or sells a patented article; such a patentee may recover damages even absent notice to an alleged infringer.  On the other hand, the patentee who either directly sells the patented article or indirectly introduces into the market through a licensee, cannot collect damages until it either begins providing notice or sues the alleged infringer.  Any resultant damages are limited to the period after notification.  A patentee can cure the marking dilemma by beginning to mark (or have the licensee mark) its products in accordance with § 287.

The public policy behind § 287 is threefold: to (1) help avoid innocent infringement; (2) encourage patentees to give public notice that the article is patented; and (3) aid the public to identify whether an article is patented.   Arctic Cat at 8 citing Nike, Inc. v. Wal-Mart Stores, Inc., 138 F.3d 1437, 1443 (Fed. Cir. 1998).   Failure of a patentee to inform the public that an article is patented is deemed problematic because of its potential to mislead others into believing they are free to make and sell an article that is actually patented and then finding themselves on the receiving end of a patent infringement lawsuit.

The statute also actually provides incentive to the patentee to sell marked products so as to maximize its damages in any subsequent patent infringement lawsuit by a “knowing” infringer. That is, the marking statute imposes notice obligations on the patentee.  Whether or not the alleged infringer may have had mere knowledge that unmarked patented articles were actually patented is irrelevant.  A patentee who does not comply with the marking statue cannot later claim entitlement to “willful infringement” damages without establishing that the alleged infringement had been put on proper notice.

The duty to mark is not limited to the patentee but is also imposed on any licensee or assignee. Arctic Cat at 6.   The licensing/assigning patentee has to demonstrate that it made reasonable efforts to ensure any third parties’ compliance with § 287 to the satisfaction of the court.  Inexplicably, the licensing agreement between Arctic Cat and Honda expressly stated that Honda had no obligation to mark the patented PWCs.   As such, in its later filed infringement lawsuit, Arctic Cat was in no position to argue that it had made reasonable efforts to ensure labeling.  The “wrong” provision included within the patent licensing agreement with Honda executed years before proved fatal from a damages maximization perspective.

And this begs the question:  Who drafted that licensing agreement and why was the original provision referencing marking deleted?  Did Arctic Cat’s authorized representative understand the implications of what he was signing?  Did its transactional attorney explain the consequences?

From our perspective, the Arctic Cat decision drives home the point that a faulty transactional agreement may well mess up a party’s rights in a future lawsuit.  Faulty agreements can range from unartful, overly verbose, and ambiguous wording to provisions that are inexplicably contrary to federal and/or state statutory requirements and public policy.  The latter should never happen at least when a transactional attorney is involved.  Any such attorney must have a thorough understanding of the legal area the agreement involves to determine how much latitude may be incorporated into the agreement without running afoul of governing law.  Failure to do so denotes sloppy work.

The commentator handles both legal disputes involving intellectual property rights including patents and drafts and negotiates complex licensing and assignment agreements.  In my opinion the preferred approach to drafting these and other types of agreements is to draft with an eye toward future litigation whether between the parties to the agreement or a third party as in the Arctic Cat case.  Such agreements should also be drafted by an attorney with experience in the subject matter.

Considering licensing your intellectual property? Contact us to see how we can provide value to you or your company from drafting the licensing agreement from scratch through negotiating the draft (or a previously existing draft) with the other party to the agreement.  Our services including taking care to explain the agreement in detail to our clients and providing a summary of the agreement’s provision to provide for ready reference.  

WE HOPE YOU FIND THE ARTICLE INSTRUCTIVE.  HOWEVER, THE INFORMATION PRESENTED IS NOT LEGAL ADVICE AND IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY.

© Troy & Schwartz, LLC 2020

Where Legal Meets Entrepreneurship™