The Green Sheet Online Edition
September 10, 2007 • Issue 07:09:01
AdvanceMe patent ruling opens merchant funding floodgates
On Aug. 14, the U.S. District Court, Eastern District of Texas ruled against AdvanceMe Inc., a provider of merchant cash advances, in a patent infringement suit. AdvanceMe filed the suit against Business Capital Corp., First Funds LLC, Merchant Money Tree Inc., RapidPay LLC, Reach Financial LLC and Fast Transact Inc. (doing business as Simple Cash).
The defendants were accused of direct or indirect infringement of U.S. Patent No. 6,941,281, which relates to a computerized method for securing debt using future credit card receivables.
The court found that the defendants directly infringed the asserted claims of the '281 patent, but the patent itself was invalid for two reasons:
- There is prior art (meaning, examples are on record of other parties using the process before the patent was applied for in 1997).
- The patent is obvious and anticipated (meaning, any party might have thought of the process because it was a natural extension of current business practices).
"While the patent inventor, Barbara Johnson, implemented an aggressive marketing and business development program that brought this financing method to widespread use, she did not invent a new business method," stated U.S. District Judge Leonard Davis in his ruling.
"Rather, Johnson built on long-established prior art, packaged the idea in a new way, and marketed it aggressively. ... Johnson merely implemented a predictable variation of these existing methods in establishing her invention."
While Johnson's work exhibited "excellent entrepreneurship," Davis stated, "it does not entitle AdvanceMe to a legal monopoly" on this method of providing merchants funding.
"The industry will sleep better tonight," said David Goldin, President and Chief Executive Officer of AmeriMerchant, which is being sued in a companion case, AdvanceMe Inc. v. AmeriMerchant.
AdvanceMe's patent was "clearly a threat to the entire industry," Goldin said.
The defendants argued 1) the '281 patent is invalid for failure to comply with 35 U.S. Code 102 and 103 ("conditions for patentability" concerning "novelty and loss of right to patent" and "nonobvious subject matter," respectively); and 2) the patent is unenforceable due to inequitable conduct.
They sought a declaration of noninfringement, invalidity and unenforceability of the '281 patent. They also sought recovery of their attorneys' fees.
Davis ruled in favor of the defendants, but he did not grant recovery of attorneys' fees. He did, however, decree that AdvanceMe was responsible for other costs associated with the court case.
By the time of the ruling, only Reach Financial and Merchant Money Tree remained in the lawsuit.
During the legal proceedings, AdvanceMe obtained a default judgment against RapidPay. Default judgments most commonly occur when the defendant fails to appear in court.
Business Capital Corp. and Fast Transact were dismissed without prejudice. And First Funds was transferred to the companion case, AdvanceMe Inc. v. AmeriMerchant, as part of a sanction for withholding documents from AdvanceMe.
"This action permits AdvanceMe to amend its complaint to seek damages against First Funds," said Glenn Goldman, AdvanceMe's CEO.
That companion case is scheduled to go to trial in January 2008, but experts predict it will be dismissed as a result of the August ruling.
"AdvanceMe originally sued [six] companies, but it was clear that once they established a precedent with that case, they would have gone after the 25 or so" remaining cash advance providers, Goldin said.
"I believe they picked five of the smaller companies to start with because they wanted a quick ruling so they'd have precedent behind them when they went after the larger companies," he added.
"If it was the loss of market share that concerned [AdvanceMe], why not sue the largest competitors first?"
Road to an appeal
"The invalidity ruling means that AdvanceMe will not be able to enforce its patent against any other entities," said Dennis Crouch, a patent law specialist and Associate Professor of Law at the University of Missouri Law School. "However, I expect that AdvanceMe will appeal the ruling to the Court of Appeals for the Federal Circuit (CAFC). Any decision from the CAFC will likely be in 2008," Crouch added.
In fact, AdvanceMe filed a notice of appeal on Aug. 16.
Goldman said, "Although we feel vindicated that the court found clear infringement of our patent by each of the defendants, we respectfully disagree with the court's findings on validity."
The ruling, if it is not overturned on appeal, will not alter AdvanceMe's business model. Rather, it will prevent AdvanceMe from prohibiting other companies from using the computerized method for securing debt with future credit card receivables described in the patent.
"Notwithstanding the infringement found by the court, we have built a leading position in the market for our products, have set the bar for best practices and organizational excellence, and we will continue to build upon those accomplishments and extend that leadership position," Goldman said.
"We focus on driving the financial success of our merchants, our partners, our sales forces and our industry and will continue to do so," he added.
The search for prior art
"This lawsuit proves that competitors can work together for the good of the industry," Goldin said. "We came together to invalidate their patent, so their plan sort of backfired on them."
Goldin pulled together examples of prior art to prove the patent invalid. He said he made about 500 phone calls and flew back and forth across the country to uncover documents dating back to the early 1990s -- some from companies that no longer exist.
"When you call someone and say, 'I'm being sued,' the first thing they think is, 'I don't want to get involved,' not 'Oh, I want to go through all my dusty old file cabinets,'" Goldin said. "But in the end, everyone could see how important it was. It was a heck of a job."
In his ruling, Davis cited a number of examples of prior art in existence at the time the patent was filed, including the Litle & Co. prior art, the LeCard program, the Transmedia program, and the prior art reserve accounts.
"Johnson merely implemented a predictable variation of these existing methods in establishing her invention," Davis stated.
He also cited a recent Supreme Court ruling in KSR Int'l Co. v. Teleflex Inc., in which that court opined, "when a work is available in one field of endeavor, design incentives and other market forces can prompt variations of it, either in the same field or a different one.
"If a person of ordinary skill can implement a predictable variation, [U.S.C.] 103 likely bars its patentability."
'The pith and substance'
Adam Atlas, a payments industry Attorney, advised several entities in the merchant cash advance industry during the litigation. Had the judge not ruled in this way, Atlas said, all the companies in that industry besides AdvanceMe would have seen a dramatic effect on their business models.
"There were multiple cases, but this one was the pith and substance -- to use legal jargon," Atlas said. "Let me put it this way: If I was an attorney representing someone in a patent infringement case against AdvanceMe, I'd have a big grin on my face right now."
He said a couple dozen companies in the merchant cash advance industry have been watching this case carefully. And the ruling means they will not have to pay licensing fees on the basis of this patent.
"The specter of this has been hanging over the heads of everyone in this industry since AdvanceMe took action against RapidPay," Atlas said.
Goldman said, "We have licensed, and continue to license, our patented methods and systems to several entities in connection with the use of our merchant cash advance products." But, he added, "The terms of these licensing arrangements are confidential."
According to Crouch, the ruling was significant in patent law in that patent liability historically requires a single party to infringe on an entire patent claim.
"Patents covering inventions that require multiple parties, such as a merchant and payment processor, are often difficult to enforce," Crouch said.
"This case gives a broad exception to that rule and would allow a theory of 'joint infringement' when there is some connection between the multiple accused parties."
Under Reach Financial's and Money Merchant Tree's programs, all the elements of AdvanceMe's patent were performed by Reach or MMT, the merchants who enter into contracts with Reach or MMT, or the processors that enter into contracts with Reach or MMT.
"Joint infringement is a controversial theory," Crouch said.
The CAFC is expected to address issues of joint infringement in another payment processing case, BMC Resources Inc. v. Chase Paymentech Solutions LLC. A lower court dismissed BMC's joint-infringement claims Crouch said the Paymentech decision is expected within the next couple months.
Big ideas at the Gymboree
In 1984, the inventor of the patent in question, Barbara Johnson, was an owner of a Gymboree franchise. She approached several banks for a business loan but was unable to get one without attaching her home as collateral on the loan.
She knew the revenues generated by her Gymboree franchise were extremely predictable, and she approached banks to see if they would lend money on future receivables. They would not. She began to think about who had control of the credit card receivables and who would understand its value.
She realized that merchant processors could control the process for loan repayment, therefore reducing the lenders' risk and creating an efficient system that was not dependant on the merchant taking any action.
Johnson's ideas led to the inventions asserted in the '281 patent. Johnson assigned the patent to AdvanceMe. She is a member of the AdvanceMe board of directors and a stockholder.
What if the patent were valid?
In effect, the '281 patent described a method in which the merchant processor would be responsible for dividing up the revenue from card payments and splitting the revenue between the merchant and the lender or other capital provider.
This system was efficient and left the process in the control of a trusted third party. Some feared that the patent, if proven to be valid, could have been applied to other transactions that involve the splitting of credit card revenues at the processor.
"The patent concerned withholding money during processing, so it could have had a disastrous impact not only on the cash advance industry, but on the processing industry as a whole," Goldin said.
Atlas said that although the patent covered a business process rather than a technology -- and therefore could be applied to other transactions -- he didn't think that AdvanceMe would have tried to apply the patent in that way.
"The patent wouldn't have had much traction outside of this particular kind of split-funding transaction," Atlas said. "The business model isn't really different from buying receivables, which is as old as the hills.
"Applying it to another kind of transaction would have undermined the premise of the patent -- that this was a unique process. The real question is whether AdvanceMe would have gone after advance companies using an ACH [automated clearing house] model if they had been successful in these lawsuits."
Both Atlas and Goldin speculated that the suit was filed in Tyler, Texas, because that district has a reputation of being friendly to patent holders.
"The Eastern District of Texas has seen a flood of patent litigation in recent years based on its reputation as a patent-friendly court," Crouch agreed. "Interestingly, that reputation is changing as the court invalidates more patents."
Goldin said, "The fact that this district invalidated the patent shows just how clear-cut this case was."
Atlas said the judge summed it up in the ruling -- that the patent does not allow AdvanceMe a legal monopoly on a method of providing financing to small businesses.
Instead, AdvanceMe must continue competing for market share, which will benefit the economy and consumers.
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