Entity Size Determination at the USPTO

by Pepper Hamilton LLP
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Determination of an entity’s size (e.g., small, micro or standard) at the U.S. Patent and Trademark Office (USPTO) is an important issue that affects budgets and dictates the applicable fee schedules at the USPTO. Traditionally, to encourage innovative contributions of small business concerns, many fees are discounted by 50 percent for patent applicants and patentees that qualify as “small entities.” The America Invents Act (AIA), which became effective on September 16, 2011, introduced even further reductions for entities that satisfy the category of “micro entity.” An entity properly deemed a micro entity can receive a 75 percent discount off certain standard USPTO fees.

The USPTO will not challenge or review whether a size designation is appropriate. Instead, the USPTO relies on applicants to make a “good faith determination” as to whether they qualify to pay reduced fees. Errors resulting in an overcharge are refunded to the patent applicant. However, errors resulting in underpayment will result in the USPTO demanding reimbursement for the uncollected fees within 30 days. While it is difficult to invalidate a patent for such an error, failure to pay the additional fees in a timely manner may be construed as an abandonment. Furthermore, an intentional fraud on the USPTO regarding size determination may result in the patent being unenforceable.

This client alert provides an overview of the laws concerning election of small-entity status in light of recent cases, and micro-entity status under the AIA. In short, small-entity status and micro-entity status are relatively narrow categories and clients should consider their situation carefully before electing to receive these discounts at the USPTO.

The Small Business Administration’s rules for determining size make it very difficult for a venture-backed company to properly identify itself as a small entity. It also may be difficult for institutions of higher learning (IHLs) to claim micro-entity status because the USPTO has taken the position in its rule making that any entity claiming micro-entity status must first establish small-entity status. Therefore, licensed-out technology from IHLs will face the same issues over proper calculation of affiliates and control.

Small-Entity Status

The USPTO has defined four categories of concerns that qualify as “small entity”: a university, a nonprofit organization, an individual inventor, or a small business concern. The definitions for a “university,” “nonprofit organization,” and “individual inventor” are defined in the patent regulations. Notably, a wholly owned subsidiary of a nonprofit organization or of a university is considered a part of the nonprofit organization or university and may claim small-entity status.

The term “small business concern” is not defined in the patent regulations. The Small Business Administration (SBA) has sole jurisdiction over determinations of “small business concerns” and the USPTO will not accept petitions for size determinations. The SBA has defined “small business concern” as, generally, a concern, including its affiliates, that:

  • is independently owned and operated
  • is not dominant in the field in which it is bidding on government contracts, and
  • meets any applicable criteria for a particular industry concerning number of employees (usually less than 500) or annual receipts (usually less than $7 million) or annual profits (usually more than $2 million).

The SBA Size Determination Board has construed the term “affiliate” broadly to encompass almost any situation where an otherwise small company may be interacting with a large business concern. The SBA considers factors such as ownership, management, previous relationships with or ties to another concern, and contractual relationships worldwide in its determination whether “affiliation” for the purposes of size determination exists. The key factor, however, is control; entities are considered affiliates of each other when one controls or has the power to control the other, or a third party controls or has the power to control both.

The relative control over the entity rather than the actual percentage of investment or ownership in the entity is of significance for entity size determination at the SBA. For example, in Size Appeal of Novalar Pharmaceuticals, Inc., SBA No. SIZ-4977 (2008), the SBA Size Determination Board determined that an “affiliation” with an individual minority stockholder (a venture capital firm) transformed the otherwise small medical device startup company into a large business concern because the venture capital firm had the potential to block certain actions of the board constituting negative control of the entity. Similarly, in Size Appeal of TPG Consulting, LLC, SBA No. SIZ-5306 ( 2011), the SBA Size Determination Board found that a small Web design firm was a large business concern because the firm was economically dependent on a large manufacturing company as a customer.

Clients need to be aware that their business may not qualify for small-entity status if its contractual relationships or other ties affiliate it with a large business concern. Even when any one factor is not dispositive of “affiliation,” the SBA will still consider all of the evidentiary findings under a “totality of circumstances” rule.

Micro-Entity Status

Although the micro-entity provisions of the AIA have been in effect since September 16, 2011, no patent fees are currently eligible for the discount because the USPTO has not yet offered the fees or set out the rules governing micro-entity fees.

The AIA defines a “micro entity” as an applicant who qualifies as a small entity; has not been named as an inventor on more than four previously filed patent applications; did not have a gross income exceeding three times the median household income (MHI) in the previous year (MHI=$50,054 for 2011); and has not assigned, granted, or conveyed (and is not under obligation to do so) a license or other ownership interest in the application concerned to an entity that had a gross income exceeding three times the median household income in the previous year.

Applicants employed by the university who derive a majority of their income from the university, or an applicant who has assigned or has an obligation to assign to a university can also claim micro-entity status, regardless of income. Although perceived as a major loophole in the statute because an otherwise ineligible entity can become a “micro entity” if it nominally licenses its patents to a university, the USPTO has taken the position that no loophole exists because small-entity status needs to be established first in order to claim micro-entity status.

Conclusion

Size determination for purposes of paying fees at the USPTO is ultimately left to the discretion of the applicant; however, the applicant should carefully consider the rules before election of reduced fees as a small entity or micro entity.

For-profit companies are generally excluded from claiming small-entity status, with the sole exception of those that are deemed a “small business concern” by the SBA. In the life sciences industries, “small business concerns” are rare because most early-stage companies are formed by affiliating with a large business concern such as an equity investment group or high-net-worth angel investor. The mere fact that a company qualifies for an SBA grant or loan is largely irrelevant, since the SBA may ultimately rule that a for-profit company is a “large business concern” though “affiliation.”

Finally, to the extent an entity has licensed a university invention, but is also funded by large business “affiliates,” legal counsel can be invaluable in making the best decision as to whether discounted status is appropriate. The decision to claim discounted status via licensing should be based on the factual circumstances of the licensing terms, especially in light of the inadvertent loophole in the statute. While claiming small-entity status initially has the attraction of paying a discounted fee, the surprise of owing a substantial amount of money with only a short time (30 days) to pay it can be mitigated or prevented entirely with thoughtful preparation.

 

 

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