(FORTUNE Magazine) – RUSHING to introduce an instant camera by 1976, Eastman Kodak's development committee issued a startling directive: ''Development should not be constrained by what an individual feels is potential patent infringement.'' Kodak entered the market on schedule. Polaroid immediately sued, charging Kodak with violating its patents. In January, after a federal judge found Kodak guilty of infringing seven patents and enjoined it from making any more instant cameras and film, Kodak announced it was permanently withdrawing from the U.S. instant photography market. The company now faces possible damages of $1 billion or more. Startled executives around the country got the message: These days patent infringement doesn't pay. Notes Michael W. Blommer, executive director of the American Intellectual Property Law Association: ''A district court put Kodak out of the instant camera business in one day. That's something chief executives understand.'' Under U.S. law, a valid patent, one that meets the three basic standards of utility, novelty, and unobviousness, confers on the inventor the right to exclude others from making, using, or selling an invention for 17 years. Until recently, though, courts so frequently held patent claims invalid or imposed such modest punishments for infringing them that, patent attorneys say, infringement literally paid. No more. Since the Court of Appeals for the Federal Circuit was established in 1982 and was charged with handling all patent infringement appeals, patents have more frequently been upheld, and the penalties imposed for infringing have become severe. Union Carbide, Kimberly- Clark, Shell Oil, Dart & Kraft, and other defendants in infringement suits face the possibility of Kodakesque judgments against them. Interviews with close to 100 business executives and lawyers indicate a growing respect for the power of patents and recognition of the need to manage differently as a result. Companies that spend a lot on research and development are more aggressively enforcing their patents while taking almost paranoid precautions against infringing those of others. Companies that have in the past opted to infringe rather than invest in new-product development now face an expensive decision: whether to start paying royalties to patent owners or to develop alternative products. What is really giving management the willies is the trend in damages. Defendants that have been judged guilty of ''willful and wanton'' infringement can be assessed treble damages, interest that accrues while they appeal, and the plaintiffs' legal fees. Worse, judges are ordering companies found guilty of infringing to stop selling copycat products immediately, rather than allowing them to continue business as usual until completion of an appeal. Notes Gerald D. Laubach, president of Pfizer, a pharmaceutical company that has won suits protecting its patents: ''When you get caught and lose now, you can lose it all.'' CASE: Pfizer vs. International Rectifier. Complaint: Violation of Pfizer's patent on the antibiotic doxycycline. Ruling: Patent valid and infringed. Judgment (1983): $55.8 million. Threatened with bankruptcy, International Rectifier settles, handing over to Pfizer its animal-health and feed-additive businesses. CASE: Pfizer vs. American Hospital Supply. Complaint: Violation by a company subsequently acquired by American Hospital Supply of Pfizer's patent on blood oxygenators used in heart-lung machines. Ruling: Patent valid and infringed. Judgment (1985): $44.2 million. The award represents about 20% of American Hospital Supply's annual profits. The company appeals. CASE: Hughes Tool vs. Smith International. Complaint: Violation of Hughes's patent on an O ring used to seal lubricant in oil drills. Ruling: Patent valid and infringed. Judgment (1986): $205 million. Smith files for Chapter 11 reorganization and appeals. For victims of infringement, vindication has seemed a long time coming. For years a strong antipatent bias prevailed in the courts and the Justice Department, fed partly by fears that patent infringement suits might be wielded as an anticompetitive weapon. In addition, different federal courts interpreted patent laws in different ways. For example, the eighth circuit, headquartered in St. Louis, was sometimes called the ''graveyard of patents,'' ruling valid and infringed only 8.6% of all patents it adjudicated between 1953 and 1977, according to one study of the patent system. Geo. A. Hormel & Co. once considered making pork-loin fritters by a method similar to one patented by Central Soya. An opinion letter from outside counsel advised Hormel to manufacture the fritters in the eighth circuit because that court ''has not held a patent either valid or infringed within recent history.'' While the average percentage of patents upheld in all circuit courts was a relatively low 27%, ''forum shopping'' became the norm: Patent attorneys simply took their clients to the circuit known to be most favorable to their cause. PATENTS WERE AT THEIR weakest in the mid-Seventies. In the years between 1972 and 1982, the number of U.S. patents awarded each year to American inventors declined by 34%. Similarly, expenditures on research and development declined during the Seventies, to a low of 2.2% of GNP in fiscal 1978. Alarmed by America's slipping industrial competitiveness, government and industry began looking for ways to stimulate innovation and maintain the country's advantage in high technology. Congress eventually concluded that one of the best incentives to increased research would be to strengthen the patent system. Beginning in 1980, all three branches of the federal government put reforms into effect. By far the most significant of these was the creation of the Court of Appeals for the Federal Circuit (CAFC), formed partly in an attempt to foster uniformity and predictability in rulings on patents. In its first 3 1/2 years, the court, under Chief Judge Howard T. Markey, has won high marks for expertise and consistency. It has also gained a reputation for being blatantly pro-patent. Judge Markey, a crusty test pilot-turned-patent attorney, vehemently denies the charge: ''Do you think judges sit around and say, 'How many patents did we sustain last week? We better throw a few out.' That's stupid.'' He adds, ''We're pro-law, but we're not pro-patent.'' Patent lawyers disagree with the chief judge. ''The court denies it is pro- patent,'' says General Electric's chief patent counsel, Harry F. Manbeck Jr. ''But guys like me clearly regard the risk of infringement to be greater today than five years ago.'' A study conducted by Washington, D.C., patent attorney Donald R. Dunner notes that as of October 1985, the CAFC had held 54% of patent claims submitted to it valid and 52% of patents infringed. The same study also shows that in cases where the district court held a patent claim valid, the CAFC affirmed the decision 86% of the time -- markedly more often than when the lower court found a patent claim to be invalid, in which case the CAFC affirmed only 60% of the time. Perhaps as a reminder to the CAFC not to carry its zeal too far, in April the Supreme Court questioned one of the court's decisions, sending the case back for reconsideration. Patent attorneys are up to their pin-striped elbows in work as companies more aggressively set about enforcing and defending their patents. Says Maxim Waldbaum, a patent attorney at the New York law firm of Darby & Darby: ''Guys who had patents of questionable merit and scope have started bringing them out of the closet, wiping the cobwebs off of them, and prosecuting.'' RCA recently sued Wang, Burroughs, Xerox, Honeywell, Commodore, and 16 other companies, charging infringement of a now expired patent on digital video display terminals, after the CAFC reversed a lower court decision holding the patent claim invalid. One defendant, Wang, has settled out of court; total damages in the case, says a lawyer for RCA, could be ''substantial.'' In August, Procter & Gamble sued competitor Kimberly-Clark for violating its patent relating to the elastic waistband of Luvs disposable diapers, asking that Kimberly-Clark be permanently enjoined from making its Huggies brand disposable diaper with an elastic waistband. Kimberly-Clark's chief patent counsel, Jeremiah Duggan, refuses to discuss the suit but says, ''With an important product, an injunction is tantamount in many instances to going out of business. How many companies can absorb what a Kodak can absorb?'' A trial date has been set for July 1987. Procter & Gamble has also sued Frito-Lay, Nabisco Brands, and Keebler for allegedly violating its patent on Duncan Hines home-style cookies. COMPANIES THAT HAVE NOT already done so are instituting programs to motivate their scientists and engineers to come up with patentable ideas. For example, Navistar International (formerly International Harvester) recently approved a three-step incentive system that would reward employees who submit ideas for inventions with cash when they apply for a patent, again when the patent is issued, and a third time if the invention is produced. One of the most compelling effects of the new attitudes toward patents, say some patent lawyers, is an increased preference at many corporations for patenting inventions rather than keeping them as trade secrets. ''During the time when the antitrust people were breathing their fumes at patents, there was a tendency to use trade secrets,'' says William Keefauver, chief counsel on issues of intellectual property for AT&T. Now, companies say, patents are regaining favor. Trade secrets are generally protectable under state law only so long as they remain secret. Such uncertain protection has made companies reluctant to license trade secrets to others, since licensing increases the risk the secret will get out. Standard Oil Co. (formerly Sohio) has put more emphasis on the filing of patents rather than on retaining ideas as trade secrets ever since the CAFC was established. Waldbaum of Darby & Darby says the new court is turning into ''a boomerang'' for some companies. ''It was formed because corporations wanted a strong patent system to protect their patents,'' he says. ''What they didn't realize is they would be sued because someone else's patents are strong.'' Dresser Industries was recently smacked with $121.5 million in damages for infringing the same Hughes Tool patent that forced Smith International into Chapter 11. It has appealed the decision. In 1983 Shell Oil charged Union Carbide with infringing its patent on a catalyst used to make ethylene oxide, a chemical used in making antifreeze and certain fibers. Union Carbide is the largest U.S. manufacturer of ethylene oxide, with over 30% of the market. And yes, concedes Union Carbide's chief patent attorney, Thomas O'Brien, if the company loses, it ''could potentially have big damages.'' A Shell lawyer is more explicit: ''We think the economic hurt to us is in the hundreds of millions of dollars.'' The two sides are discussing a settlement. Christopher Le Maistre, director of the Center for Industrial Innovation at Rensselaer Polytechnic in Troy, New York, has some advice for infringers: ''If your strategy has been to infringe, your new strategy is to go out and license.'' That is the most cost-effective alternative, he says, because companies that infringe generally don't have sizable resources for R&D. Corporate patent attorneys have started scrutinizing their companies' patent portfolios and have become more reluctant to give R&D managers the go-ahead on a new idea or business for fear of duplicating a patented product. ''My advice to my clients -- the people who come to me and say they want to introduce a new product -- has changed in the past six weeks,'' says Kodak in-house counsel Jeffrey Hawley. ''I've told them that managers of our company just aren't going to take any risks.'' Before developing new products, companies are conducting even more extensive searches than before to check for already existing patents. Nalco Chemical, Shell Oil, and others are trying to educate their line managers about the changes in the patent field. ''I'm frightened to death for my clients in the company,'' says Shell Oil in-house patent attorney Douglas Baldwin. ''We're talking to our business people, saying, 'You have to understand what's happening in the patent field very quickly.' Yet it's so fundamentally different that it's hard to communicate to them.'' A few years ago Nalco began lecturing on ''the evils of patent infringement'' to any of its research groups that were interested. The talks have done a lot, a company lawyer says, ''to keep them on the straight and narrow.'' The current wave of worry about patents is shaking the U.S. Patent and Trademark Office. Litigation-conscious companies have pressured the office to improve the reliability of the patents it issues. Currently all U.S. patents granted since 1790, over 4.5 million of them, are stored in cabinets and searched manually; at any given time 7% of the information patent examiners need when evaluating new applications is missing or misfiled. Only patents issued since 1975 are also listed in a computer. By the year 2000, the office estimates, it will have 50 million documents in storage. To alleviate the problem and improve the quality of patent examinations, the Patent Office has nearly doubled its budget over five years to a proposed $243 million in fiscal 1987, financed mostly by a 380% increase in user fees. The agency is in the midst of a $550-million project to automate its filing system. A big question remains: Will a strengthened patent system produce the intended results -- increased technological and industrial innovation? Research and development managers argue that the increased value of patents should eventually translate into a greater willingness to spend money on research. Says G. Kirk Raab, president of Genentech, ''I can't emphasize more that patents are critical to stimulating research. They are truly meaningful -- and anybody who doesn't recognize that has a problem.'' Lester C. Krogh, director of research and development at 3M, known for the premium it places on innovation, says the importance that the company attaches to patents has increased considerably in the past five years. At the same time, he says, 3M has boosted spending on research and development from 4.5% of sales to 6.5%. According to Le Maistre, companies are more likely to get a direct financial benefit from stronger patent enforcement, because competitors will tend to take out licenses or develop their own products rather than infringe. For companies with strong R&D programs, he says, that should eventually lead to increased profits. But most managers are reluctant to draw a direct correlation between patents and spending on research. They say the ability to protect results is only one element that goes into determining a company's R&D budget. Statistics from the National Science Foundation show that the average annual rate of increase in corporate spending on R&D, adjusted for inflation, will be 5.9% for the period 1984 to 1986, roughly the same as it was for the preceding ten years. ''The people making decisions about R&D budgets don't understand yet how significant the new changes in the patent law can be,'' says Steven Szczepanski, a partner at the Chicago patent law firm Willian Brinks Olds Hofer Gilson & Lione. BRUCE MERRIFIELD, Assistant Secretary of Commerce for Productivity, Technology, and Innovation, feels that the current climate is bound to precipitate an increase in the number of patent applications filed. In fact, the number of patents issued to U.S. residents has started rising slightly. Yet for all the hoopla, American companies are receiving fewer patents today than they did 15 years ago. General Electric, consistently No. 1 in U.S. patents received, was awarded 785 patents in 1984 -- down 31% from 1971. Patents issued to foreigners, by contrast, have been rising steadily. Last year foreigners received nearly 45% of the patents issued in the U.S., and six of the ten corporations receiving the most were foreign- controlled. The Japanese, in particular, are piling up U.S. patents like poker chips. In 1985 patents issued to the Japanese rose nearly 15%; patents received by U.S. residents increased just 3%. American companies are now trying to get comparably strong protection overseas for their inventions, and in lobbying foreign governments they point to the new strength of U.S. patents. For now, though, foreign competitors seem to get a better shake in the U.S. than American companies do abroad. When Texas Instruments sued a Korean and eight Japanese semiconductor firms in January for infringing its chip patents, one defendant, Toshiba, countersued, charging Texas Instruments with infringing one of its U.S. patents. ''That's the joke of it,'' says Waldbaum of Darby & Darby. ''You now have a strong patent system, and who's going to get slapped? We are.''

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