Whatever the final outcome, Toronto software man- ufacturer i4i Inc.'s battle with Microsoft Inc. would make an entertaining movie-a computer-geek version of My Cousin Vinny. There's the quaint rural locale: Tyler, Texas, one of a handful of towns that have made the eastern part of the state the epicentre of American-and therefore global-technology patent law. And there's the climactic scene from the final day of the trial this past May: Judge Leonard Davis reading a note from the deliberating jury: "We need a whiteboard, two coloured markers and a calculator."
When those words were uttered, it was obvious that i4i had won. The jury, which had only been deliberating for a couple of hours, had clearly concluded that Microsoft had infringed on i4i's patents with some versions of its flagship Word software since the early 2000s. All that was left was to tote up the damages: $200 million (U.S.) for i4i, a 30-employee David to Microsoft's Goliath.
Unfortunately, real-life courtroom conflicts are rarely as quick and colourful as My Cousin Vinny. There are often several sequels-messy, grinding, expensive and inconclusive sequels. As of early September, i4i, which is mostly owned by chairman Loudon Owen's venture capital firm, McLean Watson, and i4i's founder and chief technology officer, Michel Vulpe, still hadn't collected a penny. But the company was on a roll. In August, Judge Davis increased the award to $290 million (U.S.). He also issued a permanent injunction-the first ever directed at Microsoft-ordering the company to, in effect, stop selling all current versions of its Word and Office software packages in the United States by Oct. 10. That's no small hit: Office generated $17 billion (U.S.) in worldwide sales for Microsoft last year.
Judge Davis's decision set the stage for what looked like a decisive showdown in late September. In August, Microsoft asked for relief from the U.S. Court of Appeals for the Federal Circuit in Washington. The court usually waits months to hear a case, but it ordered an expedited hearing for Sept. 23-two days before the publication date of this issue of Report on Business. The balance tipped toward Microsoft on Sept. 3, when it was granted a temporary stay against the injunction. Indeed, by the time you read this, several developments (about which more later) could have coloured i4i's victory. But the significance of the original verdicts for the tech industry will remain, according to patent lawyers and industry executives.
"The damages are breathtaking," says Harold Wegner, a partner at Boston-based Foley & Lardner, and an expert in patent law. "This case is a poster child for patent reform." Many legislators in Washington want to severely rein in the ability of plaintiffs to sue in any out-of-the-way jurisdiction they like, often winning eye-popping damages. Although i4i only won in May and August at the trial level, which Wegner calls "the bottom of the food chain," he says the case will be "paraded around Capitol Hill."
Demands for patent reform-long stalemated in Congress-point to the inability of the current process to keep up with innovation that, by nature, is much harder to pinpoint than in Thomas Edison's day. Accordingly, litigation has exploded-to the point where, for some companies, it's more crucial to the enterprise than the original reason it went into business.
Microsoft is not talking to the press about the case. Even if Microsoft ultimately prevails, i4i's victories in the early rounds may touch off a new wave of lawsuits against corporate giants by so-called patent trolls-venture capitalists, lawyers and others who comb through patent filings looking for software, formulas and other features similar to those in products made by big companies, and who then sue them for infringement. But if Microsoft executives ever assumed that Vulpe and Owen were trolls, or the sort of folks who would cave under relentless and expensive legal pressure, they now know they made a huge mistake.
At issue is U.S. Patent No. 5,787,449-"Method and system for manipulating the architecture and the content of a document separately from each other." That isn't a bad title. (The formal company name is pretty transparent too: Infrastructures for Information.) i4i's software allows users to customize the extensible markup language (XML) code embedded in documents-code that tags the information within, and which, with i4i's software, can be used to search through and alter a database without delving into each document.
If the story of the firm were indeed a movie, i4i's offices in a converted garment factory on Spadina Avenue would certainly look the part of a small tech outfit-hardwood floors, high ceilings, exposed wood beams, and about two dozen programmers and other staff working quietly in cubicles. As for casting stereotypes, yes, techie-in-chief Vulpe wears a Star Trek ring on the middle finger of his right hand. There is what looks like a disassembled coffee maker on his desk. It is, in fact, a robot.
Vulpe, who will only say he's in his "mid-50s," was born in Montreal. When he was 6, his family moved to Detroit, where he eventually developed a still-burning enthusiasm for music. "It was one hell of a rock 'n' roll town in the late 1960s," he says. After high school, Vulpe earned a BA in political economy at the University of Victoria, and a Masters in the same discipline at the University of Toronto in 1979. He was then hired by Geac Computer Corp., a young Ontario-based software maker. "I'd never seen a computer in my life," he says. "They were looking for bright and clever."
Geac gave Vulpe six months "to learn this programming stuff." He soon displayed a flair for it, particularly the challenge of organizing big databases. In the 1980s, much of Geac's business was in developing inventory systems for companies, as well as cataloguing and circulation systems for libraries and museums. Geac transferred Vulpe to Los Angeles for a few years. Then, the Smithsonian Institution in Washington tracked him down with a request for help.
The project was daunting-"How do you catalogue and describe every artifact at the Smithsonian?" asks Vulpe-but hardly unique in an increasingly complex, digitized world. Take an example Vulpe cites from i4i's work with U.S. defence contractors: If you printed out all the manuals needed to design, build and maintain an airplane, they would be too heavy for even a 747 to carry. And the more data there is, the more potential there is for outdated and inconsistent references-and human error-to infest it. Bolt No. 23 should be bolt No. 23 in every single document. By the early 1990s, Vulpe, working with a friend named Stephen Owens, was focused on developing a tool to organize and manipulate all that information.
In 1993, Vulpe left Geac and founded i4i, setting up shop in a second-floor office next to a Toronto shiatsu massage clinic where his girlfriend worked. At the beginning, the operation basically consisted of Vulpe and his dog, Jack. Perennially sorting out databases for corporate clients, Vulpe says he soon got "sick and tired of rewriting the same code over and over again." He wanted to make and license one software product that users could customize. "That was the way to get rich," he says.
Here's where the robot comes in: Vulpe used it to show potential investors how his software could share data among many different software applications immediately. "I would change commands in a Microsoft Word document and the robot would move," he explains. The document didn't display computer code, nor was it organized in a form-it was just plain Word. By changing the value in one document, you could change the value in an entire database. Neil Nisker, an early investor in i4i who is now president of Fiera Private Wealth, remembers this period well: "I knew that if what he said was true, this would be a very, very, very successful investment."
In 1994, Vulpe and Stephen Owens applied for a U.S. patent; it was granted in 1998, and they made the patent the property of i4i. But Vulpe needed several million dollars to develop and commercialize it. Nisker referred him to a venture-capitalist friend of his: Loudon Owen. Owen had recently returned to Canada from the United Kingdom, where he had done some work for Softimage Inc., the Montreal animation software firm he and a partner had seeded in the late 1980s. The company was sold to none other than Microsoft in 1994 for $130 million (U.S.).
Owen and Vulpe hit it off right away. They decided that Owen's firm, McLean Watson, would be the conduit for raising money from other investors. However, i4i was a hard concept to sell during the dot-com bubble: The start-ups creating the most buzz were conceptually simple, such as online stores. McLean Watson managed to raise an initial stake of $2 million, and Owen and Vulpe sealed the deal in a coffee shop in 1996. "We shook hands. He knows what that meant," says Owen. "Any sane VC would have walked out," jokes Vulpe.
Risks don't faze Owen much. Indeed, as the hard-driving business guy who complements Vulpe's nerdy programmer, he completes the array of clichés for a screenplay. Owen, 51, has an MBA from the prestigious INSEAD international business school in Fontaine-bleau, France, and a law degree from Osgoode Hall. He remains managing partner of McLean Watson.
Owen describes his background as "Scottish-Welsh, with a dash of Dutch and Other." His family has long roots in Indonesia, where Maclaine Watson (the original spelling) was founded in 1820, eventually becoming one of Asia's largest commodities traders-sugar, cotton, tea, rubber, spices and the like. The family pulled up its stakes in the late fifties after the dictator Sukarno ordered a crackdown and the state began seizing foreign-owned businesses.
The family settled in Toronto, where Owen went to high school at Upper Canada College, a place that fuelled his passion for sports. "They've added academics since, apparently," he quips. As an undergraduate at University of Toronto, he was an Ontario intercollegiate boxing champion. He also played pro hockey for IC Epinal in France for the 1977-'78 season.
In recent years, Owen has channelled most of that passion, and his own gruelling workout regimen, toward mixed martial arts-which includes elements of boxing, wrestling, judo and more. He's also chairman of the Fight Network, the Toronto-based "combat sports" digital TV network, a rival to U.S.-based Ultimate Fighting Championship.
Owen's favourite off-hours hangout is Franco Behring Mixed Martial Arts, a gym in Toronto's Leaside neighbourhood. One of the gym's namesakes, Shah Franco, is a former karate world champion and a master of Brazilian jiu-jitsu. On a sweltering night in August, I find a white-robed Owen itching to join a class of about two dozen enthusiasts. Sidelined by a knee injury, he complains, "I'm going crazy here!"
Owen often asks Franco for strategic insights on business, including the Microsoft case. "His best advice was classic Brazilian jiu-jitsu," Owen explains. "Although it may seem safer to run from a gargantuan opponent, or to hope you can land a wild haymaker punch or kick, it is actually safer to get as close as possible and stay there, so both parties have a limited range of motion. It sounded to him as if the courtroom was the best way to accomplish that."
In the late 1990s, i4i was a small operation with a handful of staffers. Yet the customers were big-time: U.S. defence contractors, tech star Newbridge Networks Corp. and other companies that needed help with large databases. One of i4i's first clients after it received its patent in 1998 was the U.S. Patent and Trademark Office itself.
Because i4i is private, it doesn't disclose its financial results. But it's safe to say that i4i's revenues were in the single-digit millions in the late 1990s. Then came a surge in 1999. The emergence of XML, which was developed co-operatively by the computer industry, allowed i4i to enhance its patented technology. The firm's head count swelled to more than 100.
After the tech bubble burst in 2000-2001, however, "our sales pipeline burst," says Owen. In the latter year, the staff shrunk to 50, and there were more cuts to come. Even after the economy stabilized, i4i's business didn't pick up as much as Owen and Vulpe thought it might. Something else was wrong.
From 2000 to 2002, i4i had been in talks with Microsoft about jointly pitching certain clients. Among them were intelligence officials in Washington who, at the end of this period, wanted to sort through data mountains in several federal departments, hoping to better understand what had happened on 9/11. But, for some reason, Microsoft decided to take care of the project by itself.
By early 2004, i4i was down to 12 employees, and business wasn't looking any better. Meanwhile, articles in the trade press and clients were sending Owen and Vulpe the same message: Microsoft was offering the same customizable XML capability as i4i. Had it lifted i4i's patented software? i4i couldn't simply look at Microsoft's code, because it's proprietary. (Even at the trial in May, only court-approved lawyers and experts saw both companies' code.)
Comparing how the two companies' software worked didn't get i4i very far, either. "It's like trying to do IT-company CSI," says Owen. There was just one option left. "The only way to get at source code is to start a legal action," says Owen. So, in March, 2007, i4i headed to the federal Eastern District of Texas.
Why east Texas? Among lawyers, it's known as a "rocket docket" -one of the districts that, partly for their procedural speed, have become magnets for certain types of cases. For technology-patent disputes, Marshall (pop. 25,000), and nearby Tyler (100,000) and Texarkana (34,000), are the most popular venues in the country. There were 322 suits filed in the district as a whole in the year ended Sept. 30, 2008, or 11% of all new patent suits in the U.S. Is that because local judges and juries are rubes who are easily swayed by slick or homespun lawyers?
Yes, there are drawls and theatrics in these courts, says Donald Cameron, an intellectual property lawyer with Toronto firm Cameron MacKendrick. And the victory rate for plaintiffs is conspicuous-plaintiffs win about 77% of the trials in Marshall, compared with a 59% rate nationwide. And, yes, local juries have handed out some whopping awards, including the biggest patent verdict ever: $1.67 billion (U.S.) assessed against Abbott Laboratories this past June because its Humira arthritis treatment infringes on a patent held by Centocor, a subsidiary of Johnson & Johnson.
But all this is only a partial picture. Only about 1 in 20 U.S. patent lawsuits make it to trial-the rest are settled out of court or dropped. And even for defendants, east Texas, far from being a hick jurisdiction, offers speed and expertise. Lawyers and judges in the area now know a great deal about technical issues. Judge Leonard Davis, for instance, once worked as a programmer and systems analyst.
Still, it can seem absurd to a layperson that, as in the Microsoft-i4i case, a plaintiff doesn't have to prove a defendant actually copied its software for a jury to find "wilful infringement" of a patent. A jury can rule that way if it finds that the defendant knew about the patent for an essentially identical product, but decided to sell its own product anyway. Microsoft acknowledged in court that several of its employees had discussions with i4i in the early 2000s, but said its programming team developed its XML application on their own.
Cameron points out that other tough legal tests also have to be met to prove infringement. The plaintiff has to show that the patented software is "new, useful and inventive." In other words, he says, "not something any idiot could have thought of."
There were several huge hurdles that i4i had to overcome in firing back at Microsoft in the U.S. Court of Appeals, according to Harold Wegner, the Boston-based patent law expert.
One big issue is the date of the invention. At the trial in May, Microsoft argued that Vulpe had sold software containing his invention to a customer in early 1993, more than a year before he applied for a patent. Then there's the optics of a particular bit of Vulpe's testimony: He said he had lied to a potential investor in 1994 when he stated that he had developed the basis of the technology in 1992. But, as Douglas Cawley, one of i4i's lawyers, told the jury in his closing argument, "this is not a trial about whether Mr. Vulpe lied." He said the issue is: "Does Microsoft use i4i's patent and refuse to pay fair value for using that invention?" He convinced jurors, but the appeals court judges may be tougher.
Microsoft also argues that the jury's damage calculations were absurd. With Judge Davis's approval, jurors concluded that there were 2.1 million users of the contentious feature of Word-a figure Microsoft says was based on unreliable estimates-and that Microsoft should have paid i4i a royalty of $98 (U.S.) for each one. The jury established its royalty rate by applying a customary 25% rule to a benchmark product: XMetaL, an XML tool sold by JustSystems Corp. for $499 (U.S.). The problem is that Word sells for between $97 and $229 (U.S.): A $98 royalty would cripple the product.
Several things could undo the victories i4i has scored so far.
First, the three-judge panel meeting on Sept. 23 could send the case back down to the trial level, which would be one way to avoid setting a precedent. (If the judges actually make a ruling, the loser could make a long-shot request to the Supreme Court to hear an appeal.) Or the two sides could negotiate a settlement before the hearing-with, say, Microsoft agreeing to pay i4i a royalty for each unit of Word sold with the disputed software. Or Microsoft might buy i4i outright. Or, putting aside the issue of any past damages, its programmers could devise a "patch" around the infringing code, and install it in new shipments.
With the hearing just weeks away, however, neither side was blinking. "They have our phone number," Owen said with a smile. Microsoft wasn't saying anything to the media, but in an 84-page filing with the appeals court, Microsoft argued that Judge Davis "should have recognized a trial run amok and interceded to prevent a miscarriage of justice."
If i4i does prevail, will it all have been worth it, considering the 15 years of sweat and money that Vulpe and McLean Watson have invested, and the long legal slog? "$290 million is not that much," says Vulpe. "We've spent tens of millions developing [the product] testing it, to get it to market." Judge Davis got things right in saying that Microsoft thwarted i4i's growth, he says: "The damage is irreparable."
Vulpe figures that i4i could have been big-even as big as Oracle Corp.-"if we'd properly developed the company." But i4i's revenues are still in the single-digit millions, and still based on customized versions of the one patent. About 90% of i4i's current customers are pharmaceutical companies that compile detailed data about every aspect of the development of drugs, as well as doctor and patient records. Much of this work is a precaution against lawsuits, including those for...patent infringement.
Hey, every screenplay needs a little twist.
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Patent trolls: All evil?
What does a patent troll look like? Not like i4i, which is an actual operating company. And a lot like Virginia-based NTP Inc., familiar to Canadians for its slugfest with Research In Motion (RIM). NTP was founded in 1992 as a patent holding company-it buys patents and has dozens in its portfolio, many relating to wireless e-mail software. But NTP doesn't produce anything itself.
In 2000, NTP sent out letters to several companies, including RIM, offering to license patents it held. When RIM didn't do that, NTP sued, arguing that the e-mail function on RIM's BlackBerry infringed on NTP's technology, and that RIM should cough up a royalty on all sales. RIM executives scoffed, at first. But in 2002, a jury in Virginia awarded $23.1 million (U.S.) to NTP. Its claim mounted as RIM appealed several times and lost. In 2006, RIM agreed to settle, and paid NTP $612.5 million (U.S.).
Such battles are a costly drag on the U.S. economy, argue congressmen and senators who want to reform patent laws. Under the current freewheeling system, plaintiffs can choose to sue in the jurisdiction that seems most favourable to them, and venture capitalists and other investors buy patents-sometimes at public auctions-purely for the sake of holding them.
But lawyers who act for patent holders say that even so-called trolls help ensure that big companies like Microsoft play by the rules. "Intellectual property companies, small companies, non-manufacturing companies and other 'enforcers' ensure that the system operates as the Constitution directed," says a paper published by Atlanta-based Robins, Kaplan, Miller & Ciresi.
John Daly