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PayPal, Palm and patents

Legal analyst Doug Isenberg writes that current events only reinforce the importance of patent law to the Internet and to new forms of technology.

If you've been ignoring patent law--either as an online business or simply as a consumer--it's time to wake up. Recent events show that, for better or worse, this important form of intellectual property protection cannot be overlooked.

Just ask PayPal.

The popular online payment company's plans for an initial public offering to raise as much as $80.5 million were temporarily derailed when PayPal was sued for patent infringement by CertCo. In its complaint filed with the U.S. District Court for the District of Delaware, CertCo alleges that PayPal's service infringes CertCo's U.S. Patent No. 6,029,150, entitled "Payment and Transactions in Electronic Commerce System."

Not surprisingly, PayPal has said that CertCo's lawsuit is "without merit." But a judge or jury--not PayPal--ultimately will decide that issue (unless the parties settle). In an amended filing with the Securities and Exchange Commission in response to the lawsuit, PayPal acknowledged that it does not know how the judicial system will treat it.

"Despite our belief that our service does not infringe CertCo's patent, we cannot assure you that we will prevail against CertCo in its lawsuit," PayPal said. "Even if we prevail, the litigation could be time consuming and expensive to defend and could affect our business materially and adversely."

Even if PayPal escapes the CertCo patent lawsuit without much damage, it's not necessarily in the clear. Already, at least one other company, Tumbleweed Communications, has written a letter to PayPal hinting at a patent lawsuit of its own, based on two patents Tumbleweed owns.

Patent law often is described as providing both a sword and a shield. Patent law often is described as providing both a sword and a shield. PayPal is wisely trying to use intellectual property to its advantage as well, by filing five patent applications of its own. If granted, the patents could be used by PayPal as bargaining chips in litigation with CertCo or Tumbleweed--or as the basis of infringement lawsuits against others.

Still, despite its IPO filing and its patents pending, PayPal--like many Internet companies--could have been more astute about intellectual property.

"We may not protect our proprietary technology effectively, which would allow competitors to duplicate our products," the company confessed in its SEC filing.

But PayPal certainly is not alone. Just two months ago, a U.S. District Court in New York ruled that Palm's popular Graffiti handwriting technology infringes a patent owned by Xerox, an aggressive pursuer of patent protection and enforcer of patent rights. The consequences--for Palm, its licensees and consumers--could be tremendous.

In a short statement on the lawsuit, Palm said it would appeal the ruling. However, if Palm's appeal fails, the handheld device maker could face significant financial damages for past infringement and be forced in the future to either abandon its Graffiti system or pay Xerox to license it. Had Palm decided to license the patent years ago, before people fell in love with the Graffiti technology, it surely could have negotiated a license fee that would have been less than it might now face.

A company that owns a patent owns an important legal right--the right to stop others from making, using, selling or even offering to sell any technology that infringes on the patent. As a result, Palm--already struggling to maintain market share, investors' confidence and its reputation for innovation--could incur a huge financial blow. And licensees of the Palm operating system, including Handspring, HandEra, Sony, Kyocera and Samsung, would be damaged by the fallout, either having to drop Graffiti from their devices altogether or having to pay to license the Xerox patent too.

Whether the licensees could be reimbursed by Palm because it granted them rights to something it did not own would depend in part on whether their agreements with Palm contemplated such a disaster (and whether Palm or its licensees had the upper hand in negotiating those licenses). At the end of the day, Palm users could pay the ultimate price, as Palm and others could pass on the costs of litigation and possible license fees in the form of more expensive devices.

As with most areas of the law, the outcome of any patent dispute certainly is not clear. The filing of a lawsuit and even a trial court's finding of liability are often just steps along a lengthy legal path. A company that owns a patent owns an important legal right--the right to stop others from making, using, selling or even offering to sell any technology that infringes on the patent. But not all patents are created equally, and many of them are subject to attack in any lawsuit, as British Telecom is learning.

BT is trying to enforce a patent on hyperlinking, which, if upheld, could radically change the nature of the World Wide Web. But BT, like many patent owners, is learning that just because it owns a patent, that doesn't necessarily mean it can enforce it. A U.S. District judge in New York already has questioned the relevance of the patent, which was granted before the Web existed. And even many patent lawyers have laughed at BT's attempts to stop anyone from hyperlinking or to force anyone to pay for the right to do so.

The PayPal, Palm and BT lawsuits highlight the importance of patent law to the Internet and to new forms of technology. Yes, seeking patent protection can be expensive and confusing--and that's often why many start-ups and even established companies ignore it. But ignoring it could prove to be an even more expensive decision.