Protecting Inventions as Trade Secrets: A Better Way When Patents Are Inappropriate, Unavailable

As the Internet economy propels us into a global, post-Industrial commercial reformation, Web-based enterprises face the need to develop ever more clever methods for allowing end users to search, select, purchase and sell. For over a century, many jurists in the United States believed that such methods could not be patented. Although courts generally found other grounds to judge the patentability of "business methods," the business method exception became an accepted tenet of patent law.

This tenet was shattered by the 1998 case of State Street Bank & Trust Co. v. Signature Financial Group Inc., in which the U.S. Court of Appeals for the Federal Circuit, the appellate court with the primary responsibility for patent law matters, dismissed this interpretation and unequivocally held that business methods and software constitute patentable subject matter that are subject to the same specific substantive requirements that must be satisfied by any patent application. This understanding, coupled with the rapid growth of the Internet and e-commerce, has resulted in a three-fold increase over the last three years in applications for business-process and software patents.

However, what has been lost in the business method and software patent craze is whether patent protection is always appropriate even if available, or whether there may be a better way to protect such an invention. In particular, while this may be somewhat of a heretical idea, not enough consideration seems to be given to whether it would be more advantageous for e-commerce companies under certain circumstance to protect their inventions as trade secrets rather than as patents. In other words, companies may want to consider protecting their inventions through a combination of patents and trade secrets.

This article explores the advantages and disadvantages of trade secrets as compared to patents, and outlines the circumstances under which protecting inventions as trade secrets may be more beneficial.

Some Pros and Cons

On the one hand, there can be no doubt that obtaining patent protection may be extremely beneficial. In general, a patent gives the patentee the right to exclude others from making, using, and selling devices that embody the claimed invention for a period of 20 years. Thus, companies can prevent their competitors from using their patented invention. In the Internet area, this means, for example, that Amazon.com can seek to prevent Barnesandnoble.com from infringing its patent for 1-Click on-line shopping. In addition, licensing of patent rights may be extremely lucrative. In fact, there are a number of companies, including Walker Digital Inc. (which claims to have filed over 250 U.S. and international patent applications) that are in the business of licensing patents.

On the other hand, however, there are certain circumstances under which trade secret protection may offer real advantages over patent protection. It is best to consider them before immediately filing a patent application for an invention. Although in the United States patent applications are secret for the first 18 months after their filing, which means that this decision can be delayed, the money saved by not participating in the patent application process is lost if the decision is put off. Therefore, it is recommended that, where possible, the decision as to whether to seek trade secret or patent protection be made as early as possible.

The first advantage of a trade secret as compared to a patent is the scope of the protection. In the United States, patent protection is available in general for "any new and useful process, machine, manufacture, or composition of matter." The U.S. Supreme Court has construed patentable subject matter broadly, suggesting that "anything under the sun that is made by man" may be patented. Diamond v. Chakrabarty, 447 U.S. 303, 309 (1980).

Despite this seemingly limitless expanse, the Court has identified three categories of unpatentable subject matter: laws of nature, natural phenomena, and abstract ideas. Thus, a new mineral discovered in the earth or a new plant found in the wild is not patentable subject matter. Likewise, Einstein could not patent his celebrated law that E=mc2; nor could Newton have patented the law of gravity. Such discoveries are "manifestations of nature, free to all men and reserved exclusively to none."

Further, within the general categories of patentable subject matter, the invention must be novel, useful, and "non-obvious" to one skilled in the art. This is a relatively high standard that many inventions do not meet and, in the crowded e-commerce area, it is becoming even harder to achieve.

In comparison, trade secret protection is far broader. In general, virtually, any "useful" information can qualify as a trade secret, including without limitation, any "formula, pattern, compilation, program, device, method technique or process." Further, with regard to technical information, trade secret protection extends to "negative" know-how, i.e., information relating to processes or inventions that do not work. Such information is not protectable under patent law despite the fact that it may reflect a large percentage of a company's research efforts. If this information becomes available to competitors, the money saved by not having to devote resources to developing concepts or ideas that do not work can instead be put to use researching and developing other, more potentially rewarding areas.

Further, technical secrets can also include computer source code. This may be of particular importance to e-commerce companies. Trade secrets also do not have to be new and non-obvious; even a small improvement to a known process can qualify as a trade secret. Internet companies thus can protect their computer source code as a trade secret even if, for example, it contains a large percentage of code that is publicly available as a software tool.

Trade secret protection extends to categories of information (other than technical or scientific information) to include "business information," such as marketing plans, business strategies, and customer lists. Internet companies thus can protect their valuable business data, including essential information about customers, employees, and special sources of supply, as trade secrets.

Trade secret protection may also be advantageous to Internet companies because trade secrets are relatively free and easy to obtain. The only cost of protecting information as a trade secret is that of ensuring that the information remains secret. Companies that have not already done so may have to incur the additional expense of setting up a trade secret protection program. However, this cost generally is far less than the total cost of filing a number of patent applications.

While the cost of filing a patent application may not be consequential for an established enterprise, it may be prohibitively expensive to a company that is just starting out. And finally, because of the concomitant advantages of implementing a trade secret protection program (such as in obtaining financing from venture capitalists), the implementation of a trade secret protection plan is a very good business practice.

Further, since it can take 18-24 months for a patent to issue after the filing of the application, and what is new on the Internet one day may be old the next, the invention may no longer have value by the time the patent issues. Under these circumstances, a cash-starved company may be better off by allocating its scarce financial resources to something other than paying a patent attorney for filing an application for an invention that may be obsolete before the patent ever issues.

Other Advantages

Another possible important advantage of protecting an invention as a trade secret is that it is often easier to discover that a trade secret has been misappropriated than it is to learn about patent infringement. In order to establish patent infringement, the patentee, of course, must first discover the infringing act. Methods, including business methods, are published in a patent for the world to see, but often it can be impossible to determine if a competitor is using the patented method or process to produce the end product.

In other words, a competitor may be using a non-infringing process to produce the same product as produced by the patented process. The information needed to file a patent infringement suit under these circumstances may be very difficult--or impossible--to obtain. In comparison, since trade secrets are by definition secret, evidence that a competitor is using a similar process and had the means to acquire the information--by hiring the trade secret owner's employees, for example--may be prima facie evidence of trade secret misappropriation.

Perhaps the most important advantage that trade secret protection may offer over patent protection is that trade secret protection can last forever, while patent protection lasts for only 20 years. Thus, if Coca-Cola had sought to protect its famous soft drink formula in the 19th century as a patent rather than as a trade secret, the protection would have ended a long time ago and Coca-Cola probably would not have become so widely known. To put it another way, once the patent expired, anybody in the world would have been free to use the process. Without suggesting that the information possessed by Internet companies may rise to the value of the formula for Coca-Cola, the possibility that trade secrets theoretically live forever makes them an important alternative to patents.

A recent change in the Patent Act also has made trade secret protection potentially more advantageous. Previously, a party who chose to protect his invention as a trade secret ran the risk that another person would seek and obtain patent protection for the very same invention. Under this scenario, the first inventor could be excluded from using his own invention. However, on Nov. 29, 1999, Congress amended 35 U.S.C. §273 to provide that it shall be a defense to an action for patent infringement if the alleged infringer actually reduced the subject matter to practice at least one year prior to the effective filing date of the patent, and commercially used the subject matter before the effective filing date of such patent. Although the prior user right defense is limited to method patents for "businesses," "method" is simply defined as "a method of doing or conducting business." Thus, under this definition almost any method--for example, operating a computer--could constitute a business method. Thus, the risk to an inventor who seeks to protect his invention as a trade secret has been greatly reduced if he can show that the invention would qualify as some sort of a business method.

Finally, the eternal life of trade secrets also makes them particularly valuable as the subject of license agreements. It is well established that the obligation to pay royalties in return for the use of a patented device may not extend beyond the life of the patent. See e.g., Brulotte v. Thys Co., 379 U.S. 29 (1964). However, there does not appear to be any such limitation with respect to the payment of royalties based on the disclosure of a trade secret.

In Aronson v. Quick Point Pencil Co., the Supreme Court upheld enforcement of a contract for royalties on a key chain covered by a pending patent application. The inventor was to be paid a five percent royalty if the patent issued, half the amount if it did not, for as long as the licensee sold the product. After the device was on the market, where it could easily be reverse engineered, the patent application was rejected.

The Court held that despite the fact that competitors of the licensee could sell the identical product without paying a license fee, the license was enforceable because the licensor did not use the leverage of a patent when negotiating the license agreement. Similarly, in Warner-Lambert Pharmaceutical Co. v. John J. Reynolds Inc., the U.S. District Court for the Southern District of New York held that the licensee was still obligated to pay royalties for the right to use the formula for Listerine despite the fact that the formula had become publicly known over 25 years before the suit was filed.

Internet companies interested in licensing their technology should consider whether to do so as a trade secret rather than pursuant to a pending patent application or patent. Licensing the technology as a trade secret can create a perpetual royalty obligation with respect to the specific licensee. However, because trade secret law provides no guaranteed exclusivity, if other competitors are able to discover the trade secret--through reverse engineering, for example--then they are free to make use of the information. This means that a licensor should grant trade secret licenses only for information or technology that is very difficult or expensive to reverse engineer.

Further, licensors that provide grants under both patents and related trade secrets must take steps to prevent a finding that the license is an unlawful extension of the patent grant by intertwining the patent rights and trade secret rights. Therefore, the license agreement should carefully separate the consideration for the patent rights from the consideration for the trade secret rights.

What Exactly to Do?

The above discussion on the advantages of trade secrets is not meant to suggest that patent protection should never be sought, or should not be sought in most cases when available. Trade secrets are not without their risks and disadvantages as compared to patent protection.

First, as described above, trade secret law, unlike patent law, provides for no exclusionary rights. In order to have any value, the trade secret must remain secret. If it becomes known through inadvertent disclosure or through reverse engineering, the information is no longer exclusive and may freely be used by anyone who has learned the secret. Thus, the trade secret owner has no remedies against a person who has acquired the trade secret through legal means.

Second, it is usually far easier to establish the value of patents than trade secrets. Moreover, because they lack exclusivity, trade secrets are generally considered to be not as valuable as patents. This may be important to e-commerce companies that are in the process of obtaining financing. It also may be more of a challenge to set the amount of the consideration for a trade secret in a license agreement than for a patent. Third, patents can be enforced against those who "innocently" infringe the patent, while to establish a trade secret misappropriation claim, the owner of the trade secret generally must show some bad faith intent.

The bottom line is that Internet companies should consider protecting their increasingly valuable information through a combination of patents and trade secrets. If the invention can be easily reverse engineered or independently developed from a publicly available source, then patent protection may be preferable. Examples of this in the Internet arena include business methods and the like. On the other side of the coin, trade secret protection may be preferable where it would be extremely difficult, time-consuming, and expensive to obtain the information through reverse engineering. This means that Internet companies probably should seek to protect their source code as a trade secret rather than filing for patent protection.

Other criteria that should be considered when deciding whether to seek patent protection is the extent of similar technology in the area and the expected "shelf life" of the invention. As to the former, to the extent that the scope of the patent protection may be limited because of similar prior art, then trade secret protection may be advisable. This factor may become particularly important in the e-commerce and Internet area as the field becomes more and more crowded. In other words, it is going to become increasingly difficult for e-commerce companies to come up with inventions that are truly novel and non-obvious as required by the Patent Act.

With regard to the life expectancy of the invention, if it is anticipated to be valuable for only a relatively short period of time, trade secret protection may be preferable. Of course, as noted above, since patent applications in the United States are secret for 18 months, in a case in which it is difficult to determine the better protection method, a company should consider pursuing both options. The pending application can be withdrawn at any time prior to the issuance of the patent and the information then protected exclusively as a trade secret.

Finally, although patent and trade secret protection are inherently inconsistent with each other, since patent protection depends on publishing the invention to the world and trade secret protection depends on keeping the matter secret, consideration should be given to protecting the same invention by both methods. Specifically, patent protection may be sought for the invention and related information may be protected as trade secrets. Under certain circumstances this may permit companies to have their cake and eat it too.

Information and know-how may be a company's most valuable asset. In fact, for many Internet companies it may be their only asset. With so much at stake, it is vitally important that intellectual property be protected in the best way possible.

Because of recent changes in the law in this area, a great deal has been written about the advantages of patent protection and the scope of subject matter that can be protected. However, before immediately filing for patent protection, e-commerce companies should consider whether, in the particular case, trade secret protection is preferable. Such protection can offer a viable and cheaper alternative to patent protection.

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