Supreme Court sides with Microsoft in patent spat

In what could be a broader victory for American software companies, the U.S. Supreme Court on Monday ruled that Microsoft cannot be forced to pay up for patent infringement that occurs when copies of Windows are made and installed on computers abroad.

Generally, U.S. patent protection does not transcend American borders. At issue in this case is a complex exception in patent law that bars American companies from shipping "components" to foreign manufacturers, which could then combine them to make a machine that infringes on U.S. patents. The law does not, however, restrict sending blueprints that could theoretically prompt a foreign company to build an identical product.

Scarcely two months after they heard oral arguments in a patent dispute that pitted the Windows maker against AT&T, the justices ruled 7-1 (PDF) that "abstract software code" shipped by Microsoft to foreign manufacturers in the form of "golden master discs" amounts to such a blueprint, not a "component" of the invention.

"The master disc or electronic transmission Microsoft sends from the United States is never installed on any of the foreign-made computers in question," the justices said in a majority opinion penned by Justice Ruth Bader Ginsburg. "Instead, copies made abroad are used for installation."

That means under existing federal law, the company cannot be held liable for infringement that occurs as a result of those foreign installations, the justices concluded, although they seemed to invite Congress to take another look at what AT&T argued are loopholes in the law.

If AT&T wants to prevent its inventions from being copied abroad, the justices added, its "remedy lies in obtaining and enforcing foreign patents."

Andrew Leibnitz, an intellectual property lawyer for Farella Braun and Martel in San Francisco, said in making the ruling the court determined that U.S. patent law governs only the U.S. and not the world. Leibnitz said that is "recognition of a deference that the U.S. has not previously evinced in world affairs."

It's also, he said, a sign that the high court is leery of expanding patent law.

"I think it shows, if not hostility, a reluctance to see patent law applied more broadly than absolutely necessary," Leibnitz said, adding that the ruling will impact the whole software sector as well as other industries. "The Supreme Court is talking about not just software, but prototypes that are sent abroad...templates or blueprints or any other idea that gets sent abroad that needs to be combined with something physical in order to potentially infringe."

The decision could save Microsoft and other global software companies billions of dollars. When a jury earlier this year ordered Redmond to pay Alcatel-Lucent Technologies $1.5 billion in a patent dispute over MP3 audio technology used in Windows, the company noted that about half of the damages were calculated based on overseas sales of Windows PCs.

Microsoft general counsel Brad Smith called the decision "important for the entire information technology industry, adding clarity and balance to our patent system." He said he believed the damage awards in the Alcatel-Lucent case and an earlier case against the University of California's Eolas spinoff would be revisited, and the company welcomed that result.

"More generally, because Microsoft is such a large, rich company and competes in so many business areas, it's increasingly been the target of patent litigation," said Matt Rosoff, a lead analyst with the firm Directions on Microsoft. "So any ruling that decreases the amount of potential liability is a good thing for Microsoft."

AT&T Knowledge Ventures CEO Scott Frank said the company was disappointed in the court's ruling. "All U.S.-based sources of innovation--including the software development community--could benefit from patent laws that enable fair, appropriate protection and valuation of new technologies and inventions domestically and overseas," he said in a statement.

The ruling marks the latest in a string of patent-focused cases heard in the past year by the high court that have been hailed by technology companies. Separately on Monday, the Supreme Court issued a unanimous ruling designed to make it easier to weed out patents covering obvious combinations of elements.

The Supreme Court agreed to review the Microsoft-AT&T matter after a federal district court and the U.S. Court of Appeals for the Federal Circuit both found Microsoft liable not only for violating an AT&T patent covering a "digital speech coder" in U.S.-assembled computers but also in those abroad. AT&T first sued Microsoft over the patent in 2001.

The software giant didn't dispute that Windows software object code, after being supplied to manufacturers and installed on computers, gave users the ability to record, store and play back speech in a way that violated AT&T's patent. Rather, the high court case centered on whether Microsoft should be forced to pay damages not only on software code installed on U.S. machines but also on foreign ones.

AT&T had argued before the justices in February that the discs are far more than a simple set of instructions. It argued that the information on the discs constitutes a critical component of the product--and that software is so easily encoded into a tangible copy that the extra step undertaken by foreign manufacturers to duplicate the master disc and then install it onto a machine should make little difference.

The majority of the justices disagreed with that logic. "The extra step is what renders the software a usable, combinable part of a computer; easy or not, the copy-producing step is essential," they wrote. "Moreover, many tools may be used easily and inexpensively."

AT&T also argued that the way the law is written provides a loophole for companies to avert patent infringement damages by arranging for copies to be made abroad from U.S.-supplied master discs. The Federal Circuit appeals court sympathized with that concern, but the Supreme Court said any perceived "loophole" would be best addressed by Congress.

Justice John Paul Stevens said he would have chosen to uphold the Federal Circuit's findings. In his dissent, he said he disagreed that abstract software code is analogous to a blueprint.

"Unlike a blueprint that merely instructs a user how to do something, software actually causes infringing conduct to occur," he wrote. "It is more like a roller that causes a player piano to produce sound than sheet music that tells a pianist what to do."

The U.S. software industry, including the open-source community, and the U.S. Department of Justice's Solicitor General had filed briefs on behalf of Microsoft in the case. They contended that a ruling against the Windows maker could expand its vulnerability in patent infringement suits compared with global rivals and make it more attractive to locate its research operations abroad. AT&T countered that software companies need only worry if they're committing infringement in the first place.

Emery Simon, counselor to the Business Software Alliance, which counts Microsoft among its members and backed its Supreme Court position with briefs, hailed the decision as an important step in "rebalancing patent law," which he said has been skewed too far in favor of inventors.

The trade association had been pressuring Congress to scale back the section of the law governing the international exports as part of broader changes it has vowed to enact. Simon told reporters in a conference call that such changes are no longer necessary "because we think the court got it right."

Notably, the high court also did not declare that software is unpatentable--a move that Microsoft, for one, embraced. "It is important for patent laws to continue to provide an incentive to innovate for software, just as it does throughout the rest of the economy," Smith said in the company's statement about the ruling.

In an unlikely alliance, developers of free and open-source software had filed briefs with the high court in support of Microsoft with the hope that the justices would proclaim once and for all that software is not patentable.

Instead, the court attempted to draw a line: It ruled that "software in the abstract" is not patentable when it is simply a set of instructions detached from any medium--an "idea without physical embodiment." But the ruling suggests that copies of code that can be, for example, downloaded from the Internet or inserted in a CD-ROM drive and installed on a computer do qualify as patentable.

Ed Black, president of the Computer & Communications Industry Association, which counts Microsoft and Red Hat among its members, said that although his organization supported the Supreme Court's overall conclusion about the application of patent damages abroad, "some of the discussion relating to software patents and to software and what they are and how they should operate within the patent system need further study to understand the implications."

He added, "It points up some of the inherent problems when you apply patents into the software world."

CNET News.com's Ina Fried contributed to this report.