Why Microsoft Played a Low Ball Before the High Court

Joe Wilcox The big question hanging over today's hearing before the Supreme Court is "Why?" If Microsoft wins, the ruling could put limitations on the company's ability to collect on software patent infringements overseas. Microsoft is a big holder of valuable software patents.

The case dates back to 2001, when AT&T sued Microsoft for violating a patent for speech technology shipping with Windows. Three years later, the two companies settled, with Microsoft retaining option to appeal. If Microsoft wins, AT&T wouldn't be able to collect on infringing Microsoft products sold overseas. Victory also would limit Microsoft's own ability to collect on patent violations.

"Why would you take the position for restricting software patents when you are in the business of making software?" asked Stephen Kramarsky, a patent attorney with Dewey Pegno & Kramarsky in New York.

The answer is as complex as Microsoft's court argument—and the twain are closely connected.

Beyond the potentially large financial liability, Kramarsky observed one reason for Microsoft advocating a position that could limit the reach of U.S. patent protection.

"Microsoft has to worry about being a target," he said. "It's much more concerned about being sued than suing."

Microsoft: Software Isn't a Component
This morning, lawyers for AT&T, Microsoft and the U.S. Solicitor General's office presented oral arguments to eight of the nine Supreme Court justices. Chief Justice John Roberts recused himself because he owns Microsoft stock.

Theodore Olson, a partner with Gibson, Dunn & Crutcher in Washington, D.C., presented oral arguments for Microsoft. Olson, like AT&T attorney Seth Waxman, carried stature for being a former U.S. Solicitor General. Waxman is a partner with WilmerHale in Washington, D.C.

The Patent Act, or Title 35 of the United States Code, governs U.S. patents, in this case Section 271(f). A lower-court ruling determined that under Section 271(f), Microsoft was liable for patent infringement of Windows copies sold overseas.

The ruling was somewhat surprising. "U.S. law usually protects infringers living in the United States," said Gary Abelev, a partner with Dorsey & Whitney in New York.

"Microsoft argues that its actions do not satisfy 271(f) because (1) software code itself (separated from a physical disk) cannot be a component because it is not physical and (2) only copies of the code are installed," explained Dennis Crouch, a lawyer with Chicago-based McDonnell Boehnen Hulbert & Berghoff, in a post on the Patently O Patent Weblog.

The component question dominated the exchange between the justices and Olson. From the court transcript:

"Justice [Anthony] Kennedy: 'So are you saying that neither the source code nor the compilation are a component?'

"Mr. Olson: 'Of the foreign? The language of the statute is the foreign manufactured product. Those are the computers that are sold abroad. It is our position that the only components that are in issue in this case are the physical manifestations of the object code on a hard drive or on a disk.'

"Justice Kennedy: 'So that neither the source code nor the compilation are a component, save as, the compilation is put on a disk?'

"Mr. Olson: 'That's correct.'"

The crux of Microsoft's core argument is that the software is copied from a gold master before being assembled with a computer. If the software is copied first, it's not really a component and therefore no patent infringement.

If Not a Component, Then What?
Kramarsky believes that there is much more behind Microsoft's component argument than winning the case. "[Microsoft] wants to separate its software from the hardware," he said. Section 271(f) would continue to apply to hardware, while Microsoft would gain a kind of patent carte blanche for its software. The result would be Microsoft's second big patent benefit from winning the case.

Beyond the legal nuances, where Microsoft might have a point, the component argument falters as a practical argument. Microsoft strongly discourages any PC manufacturer from shipping a computer without an operating system. While, because of the U.S. antitrust case, Microsoft can no longer stipulate that PC manufacturers ship Windows, incentives remain for shipping an operating system. By sheer market share, the operating system is most likely to be Windows.

The operating system is a functional component of the PC. If Microsoft's own marketing material is to be believed, the operating system is the most important component of the PC. For all practical purposes, there is no functional PC without an operating system.

"A PC is pretty useless without an OS," said Michael Silver, a research vice president with Gartner.

How then can Microsoft reasonably argue that Windows isn't a component?

Justice David Souter may have wondered the same thing. During Daryl Joseffer's oral argument, Souter pressed the assistant to the U.S. Solicitor General on software as component. Joseffer seemingly took a contrary position to Microsoft. Joseffer was there to support Microsoft's position. From the court transcript:

"Justice Souter: 'The software is the component?'

"Mr. Joseffer: 'Well, but the, the—but like with anything, you could say a computer is also the component, but it's the actual computer, not you know, any copy of the same computer.'

"Justice Souter: 'But in this case, you're—but Mr. Olson said the component is either the disk or the portion of the hard drive to which the, the coded instructions are transferred.'

"Mr. Joseffer: 'Right.'

"Justice Souter: 'Do you accept that?'

"Mr. Joseffer: 'The United States' view—I'm not sure exactly how much we disagree on this—but the United States' view is that, for example, a blank disk is not a component of this invention because you don't need a blank disk to practice this invention. The—the actual component is the physical substantiation, the physical copy of the software that's inserted into a computer and if you get a disk ...'

"Justice Souter: 'In other words, the disk plus the—plus the coded instructions.'

"Mr. Joseffer: 'Yes. And again the coded—the software could be on a disk or it could be on some other technology.'"

Consideration: Software Piracy
Microsoft and some of its supporters position the case as a threat to software innovation. In a statement issued today, Brad Smith, Microsoft's general counsel warned, "If the lower court's ruling is allowed to stand, it will have the net effect of providing an incentive for companies to focus their research and development efforts in other countries to escape increased costs and liability under U.S. patent law."

Kramarsky scoffed at Smith's conclusion as being "ridiculous." Companies like Microsoft would never move valuable research and development operations outside the United States because "the patent protections are here." The risk of losing valuable intellectual property overseas would be too great, he emphasized.

Flipped around, though, Microsoft is losing valuable intellectual property overseas through software piracy.

"Microsoft may be saying, 'We're willing to lower patent protections [overseas], where piracy rates are very high,'" Kramarsky said. By lowering the patent threshold, with the expectation piracy would spread Windows' adoption, Microsoft could make important inroads against free software and a foundation for other Microsoft products—some of which are difficult to steal. If Microsoft isn't go to sue the pirates over patents, overseas protections could actually become an encumbrance.

A final consideration is the potential impact on other Microsoft software. Being a litigation "target," as Kramarsky described them, products like Office or Windows Server could become more vulnerable to patent problems overseas. While the cost of the AT&T case might be limited to a few "hundreds of millions" of dollars, Microsoft's larger liability could be in the "billions," Kramarsky said. Litigation, rather than actual liability, would be Microsoft's greater concern.

The Supreme Court's ruling is expected before its session concludes in early summer. Kramarsky expects the court would make some change, unless there is a tie among the judges, which would favor AT&T. A tie is possible because of the Chief Justice's recusal.

"I doubt they're taking [the case] to say that the [United States Court of Appeals for the] Federal Circuit was right," Kramarsky said. Likeliest outcome: The Supreme Court would reinterpret the law for the lower court and "give them a new standard to rule against."

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