United States Patent No. 7,219,079B2
Partners in a major New York law firm are among the inventors of United States Patent No. 7,219,079, issued by the U.S. Patent Office on May 15, 2007. The invention generally pertains to corporate debt instruments that are convertible to equity and that carry a contingent, deductible, interest payment. Liquid Yield Option Notes, or LYONs, are an example of this sort of debt. Various claims recite the limitation of taking a tax deduction for accrued interest that has not yet been paid, which is a basic feature of the original issue discount regime.
The described instrument sounds similar to the one described in Rev. Rul. 2002-31, 2002-1 CB 1023, as well as the group of instruments discussed in many articles and CLE programs, such as Kleinbard, et al., “Contingent Interest Convertible Bonds and the Economic Accrual Regime” (PLI 2006). The Patent Claims
The patent includes 32 method claims. Claim 1 recites generally, in part, the steps of (a) issuing the financial instrument, (b) agreeing to repay the principle according to a predetermined term, (c) agreeing to make a payment according to certain conditions, and (d) converting the instrument upon request according to certain conditions. That is, the inventors claim to have invented the convertible, contingent payment bond. Merrill Lynch introduced LYONs in 1985 and has underwritten many issuances of such securities. Persons concerned about whether this patent covers their activities will be looking closely to determine whether the elements of the claims were present in commercial products or published descriptions of similar instruments dated more than one year before the patent’s priority filing date of August 10, 2001. To be valid, the patent must be more than an obvious advance beyond any such prior business practices.
The Tax Result
To be clear, this patent does not patent the tax result; it patents the business process that has the incidental effect of producing the tax result. Claims 9, 10, 19, 30 and 31 of the patent recite that the patented method includes the step of taking a deduction based on the yield of a non-convertible fixed-rate note.
In starkest form, a patent like this means that a certain way of obtaining a tax result, which the IRS evidently allows, will require those that use the patented business process to obtain a license from the patent holder to practice the claimed invention.
The current impact of this patent may be less than in years past because the use of contingent convertibles has decreased in recent years. The reason is the change in accounting rules that requires such instruments to be reflected as a dilution of its shares by the issuing public corporation.
With patents like this one, the patenting of tax advantaged business processes moves into the center of the business world, affecting more than estate planning tools. Presumably, responsible counsel would not have obtained such a patent if they did not intend to enforce it. Patent litigation suits can be very contentious and expensive. Debt issuers should keep an eye on such developments as they consider new issues.