By Adam Atlas
Attorney at Law
Merchant advance companies waited anxiously for a decision in the litigation involving AdvanceMe Inc., Rapidpay LLC and other parties. On Aug. 14, 2007, Justice Davis in the U.S. Eastern District Court of Texas delivered a judgment that will have a lasting effect on the merchant advance market.
This article explores the case's background and ramifications.
Merchants are frequently in need of cash when they have already exhausted all other sources of available credit such as bank loans, lines of credit and credit cards.
Banks often refuse to lend money to merchants in this situation because there is no obvious way to secure the loan, and lending money to a merchant who is already in debt to other banks is inconsistent with normal underwriting guidelines.
The creative entrepreneurs of the cash advance market, including AdvanceMe, developed a product called merchant advance that allows a merchant to pay back a cash advance by directing its processor to split credit card receivables between the merchant and the company that gave the cash advance.
A cash advance is usually more expensive for a merchant than a loan. But for many merchants, it is their only choice. The cash advance industry is very active in the United States and is slowly emerging in Canada.
The litigation that is the subject of this comment involved AdvanceMe asserting its rights in U.S. Patent No. 6,941,298 (the 281 Patent). In brief, the patent is a computerized method for securing debt with future credit card receivables.
It describes a method whereby a merchant processor is responsible for dividing the revenue for credit card payments and splitting the revenue between the merchant and the provider of capital.
The process described in the 281 Patent is commonplace in the merchant advance business today. A copy of the patent can be downloaded from the U.S. Patent and Trademark Office (www.uspto.gov).
The owner of a valid patent has the right to exclude others from making, using, offering for sale, or selling the patented object.
For example, an equipment manufacturer may have a patent on a particular model of POS terminal. The owner of that patent would have the legal right to prevent any other person from creating, selling, leasing or otherwise using the POS terminal in question.
The 281 Patent is not a patent on a tangible object, such as a POS terminal; it is a patent on a business process.
AdvanceMe was the plaintiff and sought to assert its rights in the patent versus the defendants, who were an assortment of companies involved in the merchant advance business.
AdvanceMe was asserting its right to exclude other entities from using its patented business process. There are many merchant advance businesses that were not named as parties in the litigation.
As such, the litigation was likely instituted to test the validity of the patent against a limited number of defendants before seeking to assert it against the market as a whole
Because of the awesome power of a monopoly granted to a patent holder, the law sets a very high threshold for the granting of a valid patent.
Any person who invents or discovers a new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof, may obtain a patent.
One of the necessary criteria for a valid patent is that the claims made in the patent are novel and nonobvious.
Whenever an application is made for a patent, thorough research is conducted into the subject of the patent application to ensure that no one has previously (before the patent in question) had the idea contemplated in the application.
If research produces a prior use or description of the use of the proposed patent, the application will likely be denied. That earlier use of the subject of a patent application is called "prior art."
Prior art can be an earlier use of the same invention or a simple description of the invention that may have appeared in a newspaper or journal article at any time before the application for the patent in question.
From time to time, prior art on a given patent is discovered only after the patent has been granted. That prior art can then be used to invalidate a patent.
In the AdvanceMe case, the Court ruled that the 281 Patent was invalid because it was anticipated and obvious.
The defendants in the case brought a number of examples of prior art to the attention of the Court. While the Court reviewed a variety of prior art in making its decision, the one that received the most attention in the judgment was a service delivered by Litle & Co. in conjunction with National Processing Co. and First National Bank of Louisville.
Their service was an automated system that provided advances for postage to merchants. The Court held that although the Litle & Co. prior art anticipated the 281 Patent, the totality of the prior art rendered the patent obvious.
In brief, AdvanceMe was not the first company to think of the merchant advance business. Its patent was therefore invalid. (A full copy of the judgment is available under the Documents tab at www.adamatlas.com.)
From a legal perspective, this case reminds us that ideas that seem new may not necessarily be so. Every payments industry tradeshow highlights a rainbow of new payments businesses.
The entrepreneurs promoting these new businesses often believe they were the first to think of the idea they are selling.
The AdvanceMe case illustrates that long before Internet-protocol gateway payment processing was done in under three seconds, there were methods of doing business that are applicable to today's technology.
Inventors who spend years and fortunes investing in patents on business processes should be warned by this case that prior art may exist for a business they believe they have invented themselves.
The judgment is useful for payments industry businesses other than advance companies because it contains descriptions of various parts of the merchant acquiring business that rarely show up in judgments.
I believe this case will be cited in future litigation involving payment processors.
An important aspect of the advance business that was not discussed in the judgment is how it differs from the business of lending money.
Virtually all merchant advance companies represent that they are not money lenders. Instead, they supply a cash advance in exchange for a fixed set of future receivables to the merchant.
So long as advance companies are not characterized as money lenders, they avoid having to comply with a thicket of licensing and regulatory requirements imposed on money lenders. Not having to comply with those requirements gives advance businesses considerable flexibility to service their clientele.
Advance companies all across America rejoiced when this decision was handed down. The specter of the AdvanceMe patent being valid loomed over the industry like the sword of Damocles. It threatened to eat into profits of every advance company in the nation.
When this judgment was rendered, it was a green light on the advance industry to go out and make their profits without concern that they may one day have to pay a license fee to AdvanceMe.
The cash advance business is worth following. This is the golden era of the merchant advance business in America. The market is active, merchants are enrolling and re-enrolling for these services, and everyone involved appears to be happy.
In the absence of a valid patent, the Court said the plaintiff must continue to compete in the marketplace for its share of the market, which will benefit the economy and consumers as a whole.
In publishing The Green Sheet, neither the author nor the publisher is engaged in rendering legal, accounting or other professional services. If you require legal advice or other expert assistance, seek the services of a competent professional. For further information on this article, e-mail Adam Atlas, Attorney at Law, at atlas@adamatlas.com or call him at 514-842-0886.
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