Earl Warren: Mr. Bender, you may continue your argument.
Paul Bender: Mr. Chief Justice, may it please the Court. Yesterday, I tried to show how petitioner’s argument in this case was wrong in two respects, first of all, by giving to applicant’s readjustment under the 1946 statute, a higher basis for income tax purposes, then a purchaser would have had under the statute. Petitioner's argument ignores a direction of the statute to treat the vessel and the purchaser and the applicant for adjustment as if the vessel were being sold to the applicant on the date of the enactment of this Act. Second of all, I tried to show that petitioner's argument by giving it greater depreciation, then its economic investment on its own theory of economic investment would give it obviously too much depreciation and an unfair competitive advantage. I said that today I would try to show how my close application of the provisions of the 1946 Act, you could and should reach the result for which the government contends, name it that the basis to an applicant for adjustment under the 1946 Act is the basis the applicant would have had as a purchaser under the act. For that purpose, again, I shall have to refer to figures and again I shall try to restrict them to the figures on page 7 in the brief. Let me first go, recapitulate somewhat what Mr. McConnell did yesterday in giving some of the background of the statute. As Mr. McConnell said, the 18 vessels connected with this case were bought by the taxpayer between 1942 and 1946 for prices which were quite high reflecting war time cost of the vessels. The prices paid appear on line one of the schedule on page 7, and that is about $47 million. The purchase price was paid for these ships in cash and also in mortgages and also in trade-ins of other ships. I don't think there's any need for us to worry further in the argument about the exact method of payment. And I think the taxpayer agrees that it doesn't matter in this case whether the payment was made by cash or trade-in or mortgage.
Potter Stewart: You have a figure of 46, maybe a 973?
Paul Bender: Right.
Potter Stewart: And he has a figure of $49 million 582 on this.
Paul Bender: The difference is the trade-in of ships, ours is exclusive of trade-in that is --
Potter Stewart: Now it's $2 million and 6, I see.
Paul Bender: Yes. If you add those together you get the same figure. Now during the war, these ships were all charted back to the government under bareboat charters. The amount of charter hire received was about $13 million, that appears on line 4 of this chart. Also, as it came out yesterday, during the war while these boats were being charted to the United States, petitioner took depreciation on the vessels in computing its income taxes on this $13 million charter. The depreciation was about a $11 million, so you have up until the time of the petitioner buying the ships for $47 million, chartering them back to the government for about $13 million. Taking that $13 million into income for federal income tax purposes, meanwhile, depreciating the boats of federal income tax purposes by total of about $11 million. So at the time the Act is passed in March 1946, I think it's quite clear that the basis of the ships has been depreciated down from the original cost about $47 million by the amount of depreciation taken about $11 million. Now comes the 1946 Act. Again, as Mr. McConnell described yesterday, the purpose of the Act in general was to sell all these ships which the government had acquired during the war to private parties at stable prices called the statutory sales price. These prices were roughly in the case of cargo vessels which are involved in this case, about half what those vessels had cost people during the war. Anyone could buy one, speaking in general. Now, if that is all the Act have done, it would have been a bit unfair to people who had bought ships during the war at double the statutory prices. So the Act contains a section, Section 9, which provided that persons who had bought vessels during the war could apply for an adjustment. And the problem here is the effect of that adjustment which petitioner applied for and received upon petitioner's basis for income tax purposes. Let me try if I may to summarize for you, the nature of this Section 9 adjustment. The provision to Section 9 seemed enormously complicated. There are eight subsections and then there's also subsection 9(b) and there is also Subsection C, but it's not as complicated as it seems on the face of it. Essentially, there are three parts to the adjustment. The overriding purpose of the whole thing is as I said before, to put the purchaser in the position he would have been at if he bought the ships under the Act. Therefore, the first part of the adjustment which is contained in subsections 9(b) 1 through 4. Those are on the pages 11a and 12a of the appendix to our brief and to some extent in 9(b) 7, provides that a credit shall be given to the applicant for the difference between the price he paid during the war and the statutory sales price, in this case that amount was $29,287,000, that's line 3 on page 7. That gives him back the difference between the high price he paid in the statutory sales price. But that alone, excuse me, I like to emphasize now that this -- for that chambers, for that credit in the statute, no income tax consequences are provided. It simply provides that a credit shall be given for the difference in price. No, that payment to the applicant is not a taxable payment. That alone however, would not put the applicant in the position he would have been in had he bought the ship after the Act because he had used the ship during the war. He had charted it to the government and received $13 million in charter hire and in fact he paid income taxes on that amount. So the second part of this adjustment is an unwinding of the transactions which the applicant actually entered into with the ship during the war. Now that part is contained in subsections 9(b) 6 and to some extent in 9(b) 8. What the Act provides is that all the charter hire, which the applicant received from the United States during the war should be returned to the United States. Now in -- since the applicant had paid income taxes on that amount in return for that, those amounts are treated as if they had never been received in income and the applicant's income taxes are recomputed as though those amounts had never been received in income that's provided in 9(b) 8 by applying the provisions of 9(c) 1. 9(c) 1 is quite explicit on that amounts credited to the Secretary under the Section 9(b) 6, that is for charter hire, shall be treated for Federal Tax purposes as not having been received but accrued as income. That alone however, still wouldn't have been enough because the applicant was taking depreciation deductions on these ships and if you just took the amount out of income, he would have these enormous deductions, $11 million, but no income to offset them. So he either have -- it would either be offset of other income which he had for which he wouldn't be entitled to the deductions or he have a loss which he would carry over to other years. So is it part of the total unwinding, we have to take away those depreciation deductions also and that's provided in 9(c) 1, depreciation amortization allowed or allowable for Federal Tax purposes shall be treated as not having been allowed. Well that's then the second part of the adjustment. You give back the charter hire and you recompute the taxes as though the charter hire had never been received and as though depreciation deductions had not been allowable. Now notice that there, Federal Tax consequences are very clearly provided in the Act for the giving back of charter hire, there is a corresponding lowering of federal income taxes. You take that amount out of income and you re-compute the taxes as though that amount had never been paid as income, even though it had in fact been paid. Essentially, it amounts to a deduction from federal income taxes for the years in which the charter hire has been received. Now, even those two things alone do not completely put the applicant in the position he would have been in, had he not bought the vessels until the date of the Act. Because, if he hadn't bought the vessels, he wouldn't have traded in vessels, in this case the applicant traded in 4 vessels and those vessels, he would have charted to the government by trading them and he didn't. Also in buying the vessels he made quite a substantial economic investment. If he hadn't made that economic investment, he would have invested the money some place else or put it in the bank and receive some income on it. So the third part of the adjustment which the Act provides, is to give him the income he would have received during the war if he hadn't purchased the ships until the date of the Act, and that's provided in 9(b) 5 and 9(b) 6. One, we give him the charter hire which he would have received on the ships traded in. Two, we gave him interest at the rate of 3.5% on the economic investment he made in the ships. Again, corresponding to that payment to him which would have been ordinary income if it had been paid during the war, we impose federal income taxes on that. Again, that's provided in 9(c) 1, amounts credited to the applicant under subsections (b) 5 and (b) 6 shall be treated for Federal Tax purposes as having been received and accrued as income in the taxable year which was on the date of the enactment of this Act. So, these amounts are credited to him and income taxes are imposed upon the applicant in the year 1946. Those three things together, you give him back the difference in purchase price, you impose no tax consequences on that. He gives you back the charter hire, you give them back the income taxes you paid on the receipt of the charter hire and we give him income he would have received if he hadn't purchased the ships an imposed taxes on that amount essentially, not completely, not exactly but essentially put the applicant in the position he would have been had he not purchased the ships until the date of the Act.
Arthur J. Goldberg: Mr. Bender, where in your chart on page 7 does he give back the depreciation?
Paul Bender: Well, he doesn't give back the depreciation. We take out of his income for the years in which he received charter hire, the charter hire he received. We also disallow for those years as deductions, the depreciation, the sum -- then we re-compute his taxes. The sum of that re-computation is in line A, $430,206 that's a --
Arthur J. Goldberg: [Inaudible]
Paul Bender: The precise figures do not appear in the record. In the petitioner's appendix, you can find the depreciation figures in Exhibit G in the interim agreement and they add up to as we say in the brief over $11 million, but the precise tax calculations were not put in the record. The only thing that appears in the record is the sum of the re-computation of taxes for all of these, not only the giving back of the charter hire but also the substituted charter hire and that's --
Arthur J. Goldberg: [Inaudible]
Paul Bender: Yes, yes, yes.
Arthur J. Goldberg: [Inaudible]
Paul Bender: Right, right. Now, the essence of our argument is that because of the tax consequences provided for the second and third parts of the adjustment I've described, that is the imposition of income tax on the charter hire an interest credited to the applicant and the forgiveness of income tax on the charter hire which the applicant pays back to the United States, because of these tax consequences, those parts of the adjustment have no effect upon basis. Essentially, we argue that an amount paid by a buyer to a seller on which he takes a deduction from income, for Federal Tax purposes doesn't affect his basis. On the other hand, an amount paid by a seller to a buyer which is taken into income by the applicant -- by the buyer doesn't affect his basis. That means that the only part of this adjustment which affects basis is the purchase price credit, the $29 million. And that is the amount of that credit diminishes basis from the original price which is $49 -- $47 million by the $29 million and you come out -- now this figures on page 8, if you make that subtraction, you come out with $17,800,000 which is the basis the applicant would have had if he bought the ship under the Act. Now I'd like to try to demonstrate to you with some simple examples, not in the context of this rather complicated case why it is true that amounts which the buyer pays to the seller and which the buyer deducts from income do not affect his basis. And on the other hand, amounts which the seller pays to the buyer which the buyer includes an income do not affect his basis leaving in this case only the amount of the purchase price adjustment which has no income tax consequences under the statute. Take for an example, a very simple case. I'll use figures of hundreds of dollars rather than millions of dollars but the figures are inappropriate. Suppose a buyer buys a building, a business building for a $100 and as part of the buying agreement, as part of the contract, he agrees to rent it back to the seller for one year for $10. Now, the total amount the buyer then -- and the agreement also provides that the $10 rent shall be payable in advance at the time of the agreement. Now the total amount the buyer is going to pay in cash is $90, $100 for the building less $10 rent coming back. However, I think it's quite clear that if the $10 rental payment is included in the buyer's income for income tax purposes, his basis in the building isn't $90, his basis is a $100. Essentially, the basis is the amount he paid for the building, a $100. The $10 payment which comes back, and which is set off against the $100 payment, doesn't affect his basis because it goes into his income. And it has to be that way because if that went on for 10 years and his basis was only $90, he would have taken into income a total of a hundred dollars, $10 each year. But only gotten depreciation deductions of $90 and that wouldn't be right since he didn't have any net -- he clearly didn't have any net gain. So, I think that shows in a rather simple form, that an amount which the buyer takes into income which is offset against the amount he pays doesn't affect his basis. On the other hand, an amount he pays which he deducts does not affect his basis, take same situation of buying a building and suppose that here the agreement obligates the buyer to invest $10 in advertising, his supposed part of a real estate development and he must invest $10 in addition to the hundred dollars in the first year in advertising the building or his services and suppose even then he has to pay the $10 to the seller who's an advertising agency, and suppose that the $10 is deductible from ordinary income, as I suppose it would be. Again, he pays here a $110 but his basis isn't $110, his basis is only a hundred dollars. The only part of the payment which is capital is the $100, the $10 is deducted from ordinary income. The $10 doesn't go into the basis computation, that has to be true because if the $10 did go into the basis computation, he get a total of $120 deductions for only $110 outlay. The outlay is a 110, if he got a deduction which he did from ordinary incomes of paying $10 and if his basis was a 110, then he gets depreciation deductions of a 110 plus the 10 he has already got, and which would be a 120 for a total payment of a 110 which would be wrong. So amounts which come in, which he takes into income don't affect basis. Amounts which he pays, which he deducts from income don't affect basis. Now those examples are quite close to this case. The only difference between those and this case is that in this case, you have those payments accompanying a purchase price adjustment. But we can make the example just a little bit more complicated and put that in and then I think you'll have this precise case. Suppose again, he buys the building for a $100. Suppose now that a year or so goes by and the seller says to him, “You paid too much for the building.” The seller wants to give him a refund because of some ongoing commercial relationship they have. “I will give you back,” the seller says, “$50 of what you pay.” Now that were all if you just gave him back the $50, his basis would go down by $50, But suppose as a condition of giving back, first he says, “I'll give you back the $50 if you will rent the building to me for 10 years and the rental is payable -- I will pay you the rental at the time of the refund in advance -- rent the building for one year I suppose, $10 a year.” So how much does the seller pay the buyer back, $60, $50 is the purchase price adjustment, $10 is the advance rental payment. But the basis of the buyer is reduced not by $60, only by $50 if that $10 rental payment is taken into income just as in the past example. Now that's just like the part of this case which involves the re -- the substituted charter hire and 3.5% interest. That's just what happening in that part of this case. The government is giving back the purchase price adjustment, difference between the price originally paid and the statutory sales price and it's also paying to the buyer some income namely, substituted charter hire and the ships traded-in and 3.5% interest which by the very terms of the statute is taken into income for income tax purposes in the year 1946 and he couldn't' provide that any clear. Now, if that were all they were in the statute, just the purchase price adjustment and the return of -- and the payment of substituted charter hire, the basis would be lowered not by the whole amount in this case the $29 million plus the $2,600,000 on line 7, which -- and the $1 million on line 6 which is the substituted charter hire and interest, those amounts wouldn't reduce the basis because those amounts had taken into income for income tax purposes by the taxpayer, the basis would be reduced only by the $20 million. That's half of this case. Therefore, we submit that those amounts in line 6 and 7 substituted charter hire and a 3.5% interest do not affect the basis. The other half of this case is like the following example, which is like when I gave before. You have the same building, same hundred dollars, the same two-year later seller who decides that he has paid too much and wants to give him back $50. But this time as part of the agreement, that he'll only give him back the $50 if the buyer will agree to invest -- let's say $10 in advertising which he has to pay to the seller who is an advertising agency. And let's suppose that it's true that that $10 is deductible from ordinary income by the buyer. Now if that's all you have, what's -- the net payment is 50 minus 10, so it's only 40, but the basis isn't reduced by 40. The basis is reduced by 50. The basis is reduced by the part of the payment which represents the return of capital by the difference between original price and the new price. The $10 payment for advertising which is deductible from ordinary income, doesn't affect the basis for the reason I gave before. If it did, you deduct that amount twice. That's just like the part of this case which involves the payment of charter hire by the applicant back to the United States. That payment is a condition of receiving the adjustment. The adjustment comes to him, he must pay the charter hire back. For the payment of the adjustment to the applicant, there are no income tax consequences imposed. But, for the payment of the charter hire back to the government, there are income tax consequences. Essentially, that amount is taken out of the applicant's income for the years when it was received. It amounts to precisely a deduction from ordinary income for that amount of $13 million, it's a deductible payment. Well, a deductible payment is I think I have demonstrated before, does not affect the basis. Therefore, that amount of charter hire which is paid back to the government under Section 9(b) 6 of the Act, on which federal income taxes are forgiven because of the effect of 9(c) 1 of the Act, doesn't affect the basis. So the basis you come out with here, is simply the amount of the purchase price adjustment which is paid back the first part of the adjustment I described, which doesn't affect -- which doesn't have any federal income tax consequences. The only -- it seems to me that the only ground on which you can dispute that analysis is by saying, as petitioner does say, that in fact federal income tax consequences are not imposed upon these payments in parts two and three of the adjustment. He says, “Federal income tax consequences are not imposed on the payment of substituted charter hire income, not imposed on the payment of the 3.5% interest and on the other hand, deductions are not given for the payment of charter hire back to the government.” Now if that were true, petitioner would be right, but it just isn't so. And it isn't so because the Act provide as clearly as it could possibly provide the federal income tax consequences are imposed on those payments, and that as I say is provided in 9(b) 8 and 9(c) 1. 9(c) compels an applicant for adjustment as a means of getting the adjustment to sign an agreement, binding upon the Act in any affiliated interest and the agreement is in three parts. One, he's got to agree that depreciation and amortization already taken shall not be treated as allowable for Federal Tax purposes. Two, amounts credit to the Secretary that charter hire he pays shall be treated for federal income tax purposes as not having been received, that is, he gets a deduction for them in the re-computation of taxes. Three, amounts he gets on the 95 and 6, the substituted charter hire interest payments are treated as income for federal income tax purposes in the taxable year of the enactment of the Act, 1946. Then after he signs that agreement, Section 9(b) 8 provides that, they shall be subtracted from the credits in favor of the Secretary the amount of any over payments of Federal Taxes of the applicant resulting from that agreement. And I don't see how that could be any clear that if he has overpaid taxes because he paid taxes on the charter hire which you shouldn't pay and he gets the taxes back, those amounts shall be treated as credits and also any deficiencies in the next sentence shall be treated as credits and their deficiencies in Federal income tax of -- deficiencies in Federal income tax. Then when you come to the end of Subsection 9(b) 8, provides that upon such payment by the Secretary, such overpayment shall be treated as having been refunded and such deficiencies as having been paid. Again, it clearly emphasizes that the effect of this statute is to re-compute the income taxes and to treat any deficiencies or over payments resulting from the re-computation as paid, satisfied, obligation finished, taxes have been recomputed. Well, if – as I tried to show, if you re-compute the taxes in that manner, the only part of this adjustment which can possibly affect basis is the part of this adjustment upon which no Federal Taxes are imposed and that is the difference to credit in Subsections 9(b) 1 through Subsection 9(b) 4, the credit for the difference between the price actually paid by the applicant and the statutory price. And is --
Byron R. White: Mr. Bender, are these examples and what you've been saying that really help us in trying to understand why -- well first, do you agree that the investment here was $26 million?
Paul Bender: No.
Byron R. White: By the time that he's paid cash in the past, cash down and he made payments on the mortgage and he still has a part of the mortgage to pay or by the time he gets through paying the mortgage and you add that to his cash payments and his down payments, trade-ins, will it be 26 million or more?
Paul Bender: No, his investment is not $26 million because $8 million of that $26 million was deducted from his income for Federal Tax purposes and amounts which you deduct from your income for Federal Tax purposes can't possibly constitute investment, for Federal Tax purposes.
Byron R. White: All I want to know that is what want to ask, I asked whether or not the money he pays to the government will total $26 million or whether it won't -- whether it will or it won't?
Paul Bender: The money he pays?
Byron R. White: On the purchase price. The cash he has paid at the outset, the trade-ins, the payments on the mortgage and the balance due on the mortgage as of now, by the time he has paid the mortgage off, will all of his payments over to the government will be $26 million?
Paul Bender: Well, he originally paid 47 and if you view it that way, that he originally paid 47 and only got back 20 -- 46 only, he got back 20, it would, but that doesn't take into account the $13 million that he got during the --
Byron R. White: Well, I understand that, but -- will he pay over $26 million?
Paul Bender: No, he won't because he has received $13 million in charter hire from the government during the war. If you're just going to look at net cash payments Mr. Justice White, you have to take into account the net cash payment of $13 million.
Byron R. White: Well how about the net cash payments on the purchase price?
Paul Bender: Well, let's give him the $46 million. Let's suppose he has paid that all in cash.
Byron R. White: Yes.
Paul Bender: Now during the war, the government paid him $13 million and after the war, when he applies for an adjustment, he pays the government back $20 million, I mean the government pays him back $20 million. So the government has paid him a total of $13 million plus $20 million. He's paid the government a total of $46 million. If you're going to look at how much cash he's paid, you take $46 million and deduct the total amount the government's paid him, namely $13 million --
Byron R. White: No -- let's set aside what you said was – he had income tax consequences. I was going to put aside the charter hire payments?
Paul Bender: Well but after the adjustment is paid, the charter hire payments haven't had income tax consequences anymore because the taxes have been forgiven on those amounts.
Arthur J. Goldberg: Actually what you're saying is that they've paid on $26 million, a sum that was paid in the form of interest, charter hire and so on, and not as part of the investment, isn't that what you're saying?
Paul Bender: Well, I don't -- when you say, it paid out $26 million, I don't know quite what figure you have referenced to it. If you're just going to look at the cash which pass between the government and the taxpayer, they didn't pay the government 26 million --
Arthur J. Goldberg: Because they have some offsetting amounts.
Paul Bender: Because the $13 million came back there.
Arthur J. Goldberg: Yes. But of course, the $13 million is now being cashed back.
Paul Bender: No, it's not being given back. They only gave back 20 million, and they've given -- if the 13 -- if they got the $13 million, then they get another $20 million. The $13 million is not coming back, they're simply getting $20 million rather than a larger amount they would have gotten if the $13 million hasn't been paid back. If you're going to forget about the original payment of $13 million, you're taking that into account twice.
Arthur J. Goldberg: That's your other argument, your alternate argument that you are making?
Paul Bender: Yes essentially, but I want to emphasize that if you just look at the cash paid by the taxpayer in this case, it does not amount to $26 million, it amounts to considerably less than that.
Earl Warren: [Inaudible] the appellant should prevail in this case on his theory, what preference would he have or what benefits would he have over and above, those that were acquired by someone who bought the same ships under the Act?
Paul Bender: He would have a higher tax basis than those people.
Earl Warren: Yes.
Paul Bender: That would mean that each year, he could take a larger deduction from his income for Federal Tax purposes than those people. Therefore, if they each received the same amount of gross income, $10 million let's say, and if he was able to take a $2 million deduction but they only a $1 million deduction. Those deductions don't represent any payment, they simply represent the amortization. He would have a lower taxable income than his competitors on exactly the same gross income and that would give him a competitive advantage, lower taxable income means a higher after tax income.
Earl Warren: Very well. Mr. McConnell?
John W. McConnell, Jr.: Mr. Chief Justice, may it please the Court. I have a very short time remaining here that I would like to answer some of the questions that were raised and I think if we're coming back now to the point at which this should have begun and on which it shall be decided. And that is, Mr. Justice White's question of how much did this taxpayer pay for these vessels. Now Mr. Bender says, we didn't pay $26 million, but it's stipulated, it's in the record. It's clear we paid $16 million before any adjustment. It is clear that after the adjustment, we owed $10 million more dollars which we have paid, making a total of $26 million which regardless of how it was computed is the purchase price of these 18 vessels and therefore, the economic investment. Now, there have been several questions asked about the purpose of this of getting back statutory sales price, Mr. Chief Justice asked this yesterday. If you'll look at the comparison of the bills that we have in our Appendix C, showing the bills considered and rejected and the bill adopted, you will see that one of the bills said, “Reduce it down to the statutory sales price,” that's not the bill adopted. That's the computation you would get from Schedule 1 on page 7 if that bill had been adopted. However, it was recognized everywhere that the adjustment would not be made down to the statutory sales price and if it was not made to the statutory sales price, therefore, any taxpayer who purchased before and whose price were adjusted would pay more than the statutory sales price. We paid $26 million which is more than statutory sales price. So you do not get it down to the statutory sales price and we submit that Section 9 (b), the application of formula, will not produce this table, Schedule 1 on page 7 nor the results contain therein. And it is true that if you look at this, you will see that the government admits a net payment, and in fact there was no payment, all of this is misleading. If you look at page 7, they talk about charter hire return. No charter hire was returned. The bill rejected --
Byron R. White: Isn't there a lot of points that it wasn't --
John W. McConnell, Jr.: Exactly Your Honor. Let me go on and say the effect of --
Byron R. White: I don't think that you might owe the government some charter hire in return of charter hire that you supposed to pay them back for the – and part of its wrapped up in the mortgage?
John W. McConnell, Jr.: Your Honor, it actually wrapped up in the adjustment. These are a series of credits leading to one thing. It's not a division into three adjustments as Mr. Bender stated. You won't find in Section 9(b) anything that will give you lines 1, 2, and 3 on his schedule, it just simply isn't there. In fact, if you look at 9(b) 8, 9(b) 8 says that you must -- there shall be subtracted from the sum of the credits in favor of the commission including the credit in Section 1, where it goes on down by the taxes, it says, “If I have to make any such subtractions, the sum of the credits in favor of the applicants exceeds the sum of the credits in favor of the commission, such excess shall be paid by the commission applicant.” In other words in sub-paragraph B, you net all of these credits together. Include --
Byron R. White: You agree, then I suppose that the net credit here of 8(a) is right, $8 million, $8 is right? That you agree --
John W. McConnell, Jr.: No sir, that's not the net credit that you get on the -- under this section.
Byron R. White: But you agree with lines 4, 5, 6, 7 and 8?
John W. McConnell, Jr.: Line 4 is a credit Your Honor that -- now this is not charter hire return, this is a credit for charter hire.
Byron R. White: Alright.
John W. McConnell, Jr.: Credit should be the word $13 million is right --
Byron R. White: Alright.
John W. McConnell, Jr.: -- under paragraph 6.
Byron R. White: Yes.
John W. McConnell, Jr.: Then the credit charter hire on trade-ins --
Byron R. White: Yes.
John W. McConnell, Jr.: -- on line 6 --
Byron R. White: Yes.
John W. McConnell, Jr.: -- that's correct.
Byron R. White: Yes.
John W. McConnell, Jr.: Interest, on line 7 --
Byron R. White: Yes.
John W. McConnell, Jr.: -- that's correct.
Byron R. White: Yes.
John W. McConnell, Jr.: However, -- and also the 8, although there's no refund again --
Byron R. White: That's credit.
John W. McConnell, Jr.: That's debit.
Byron R. White: Alright.
John W. McConnell, Jr.: In this case, it's a debit.
Byron R. White: And so you must agree then if the net --
John W. McConnell, Jr.: No sir, because they have overlooked this. There's no place in there for the credit for sub-paragraph 1, where we paid more than the 25% of the statutory sales price. There, we got a credit of sum of $11 million. This is on page 48 of the record Your Honor, stipulated. Now that's under sub-paragraph 1, that's the reason I say, you can't get schedule one from Section 9(b), it's not there. They overlooked a lot --
Byron R. White: You and the government still seem to be talking about the same factors --
John W. McConnell, Jr.: We --
Byron R. White: -- the same language or even the same transaction.
John W. McConnell, Jr.: Exactly Your Honor. Let me just quote this and to get the examples that Mr. Bender gave, under Section 9(c), now we do not say that 9(c) 1 does not have tax effects. We say that the years 42 through 46 were re-computed for the purposes of Section 9(b) 8, part of the formula, that's all, recomputed. In fact, you'll find in the record the effect of this. On page 67, you can see the tax effect of this re-computation. It's a 67 in the record. If you'll look down at line 8, on page 67, this is the sheet that has the total, the last column is the total. Now if you look at this 9(a), it says deduct overpayment of Federal Taxes and in the next line and part of the same line, add deficiencies of Federal Taxes. Now over in the right hand column, overpayment 3.5 million, deficiency $3 million and 90. Now, to get to this depreciation that we've talked so much about, depreciation is not something that comes back in dollars and cents. Depreciation is a deduction allowed by Federal Law on your taxes. Now if you have no income, your depreciation is not going to help you. All the depreciation may do is either reduce your tax or in this case where we treat it as not having been allowed, it increased our tax, we paid more. This item here of deficiency of Federal Taxes, $3 million and 90, is due in part to the fact that we -- this depreciation was treated as not allowable. So that instead of depreciation being in our favor, in which trade is not allowed, our taxes went up and this became a credit. In fact again that's where schedule one is misleading, line 8, that everyone had so much trouble finding on depreciation, it's odd that's the only thing that's not mentioned as having entered in the computation of the taxes. Now, we just say that the government is not being candid in the use of Schedule 1 as to what took place here. One other thing --
Arthur J. Goldberg: I take you drew some figures. Do you dispute the fact that you received from the government $20,468,904 plus $13,430,431?
John W. McConnell, Jr.: We certainly do Your Honor, we --
Arthur J. Goldberg: Now will you tell me why you dispute that?
John W. McConnell, Jr.: Alright sir.
Arthur J. Goldberg: Because net payment to the Waterman, $20,468,904. Now item number 10 and then charter hire from the government, $13,430,431. Now, those are two items which as I understood the argument you received, is that wrong?
John W. McConnell, Jr.: No sir. Your Honor, in fact they claim item 10 as net payment which includes up there, your charter hire return, all of those words are wrong, erroneous, but that includes that above charter hire return. Now let me just explain this though. This is the way that we arrive at it and it goes back to Mr. Justice --
Arthur J. Goldberg: Well, that's equivalent. I understand that, that the re-computing, but I want to now take, forget about all the argument. Let's talk about straight cash in flow, the Waterman, just straight cash. During the period you operated, the charter hire to the government during the war, you received $13,430,431 --
John W. McConnell, Jr.: That's right.
Speaker: -- is that correct? Now after this -- all these adjustments were made, all these adjustments were made, was there a further payment of $20,468,904?
John W. McConnell, Jr.: Your Honor, there was a reduction in mortgage indebtedness in the amount of $20,554,468.
Speaker: Yes, right.
John W. McConnell, Jr.: Now, Your Honor though if you'll look at the record in the agreement entered into --
Speaker: Now before you leave it, either an actual money received or credit on the mortgage, then you received the benefit of $33,898,904, is that correct?
John W. McConnell, Jr.: No sir, Mr. Justice --
Arthur J. Goldberg: Well tell me why it isn't correct --
John W. McConnell, Jr.: Because --
Arthur J. Goldberg: -- I thought you just said, that you got it on a reduction of mortgage indebtedness which is the same as getting it.
John W. McConnell, Jr.: But Your Honor, the computation or the reduction in mortgage indebtedness took into consideration, that figure was arrived at after taking all of these other credits.
Arthur J. Goldberg: I understand that, but I'm -- I'm just trying to get the net amount after without the consequences which we have to determine.
John W. McConnell, Jr.: Well let me --
Arthur J. Goldberg: Did you in fact receive $13,000,430 and a credit of $20,468,904?
John W. McConnell, Jr.: We received during the war $13 millions of charter hire.
Arthur J. Goldberg: Alright. Did you receive a credit on your mortgage indebtedness at $20,468,904?
John W. McConnell, Jr.: That's right sir. After entering into this agreement.
Arthur J. Goldberg: I understand.
John W. McConnell, Jr.: By which it stated --
Arthur J. Goldberg: Yes. Again, I'm not talking --
John W. McConnell, Jr.: Yes.
Arthur J. Goldberg: -- about the consequence, I want to establish the fact. The fact is that Waterman received, in cash and credit $33,898,904, is that correct?
John W. McConnell, Jr.: Well yes, and although we had some offsets to this also.
Arthur J. Goldberg: Yes, but is that a correct fact?
John W. McConnell, Jr.: We received 13 million in charter hire and 20 million in mortgage adjustment, yes sir. Now, the difference if I may take just a moment in the effect of this 9(c) 1 which was a condition about making this and we entered into an agreement in which 9(c) 1 is a part of the agreement. To get back to the examples of the property purchase, a building for a $100, this is an agreement not between two taxpayers but between the taxing authority, the government and a taxpayer. The taxing authority is the only one then get back and save what depreciation will be allowable, what will not be treated as income, what will be treated had been and received as income? I and another taxpayer cannot agree on that, but the government can and the government entered into an agreement which said, “Depreciation and amortization allowed or allowable with respect to the vessel up to the date of enactment of this Act for Federal Tax purposes shall be treated as not having been allowable.” Now this is a government, not two taxpayers. So that the government who gives us depreciation or does not give us depreciation said, “Alright, we're going to treat it as if you haven't had it.” That brought our basis back up, and then it goes on down, “Amounts credited”, now notice this, credited not returned. Credited to the commission including charter hire shall be treated for Federal Tax purposes as not having been received or accrued as income. Now they didn't say it returned. We don't return it, credited. A credit that enters into the determination of the price adjustment and the government says, “We're going to treat that as not having been allowed.” Now that gives tax effects in 42 through 46, and the tax effect though then becomes a part of the computation of the adjustment and price under 8. Now therefore we say that this is not the case of where we buy advertising. In fact, if we made a contract with the government in which the government says, “You put in $10 of advertising and we'll count it is part of the capital cost then we could do it.” The government can agree to that and the government agreed to that in 9(c) 1. This is a contract between a taxpayer and a government who has this taxing authority and therefore, we say that the tax effects are limited solely to those years recomputed. And then though, you don't divide your formula on the 9(b) and the three adjustments that Mr. Bender spoke of. Nowhere will you find, look at the regulation, we ask you, we've set them out in our brief. The regulation promulgated by maritime. If you look at the sub-paragraphs, when they have the credits to the commission and the credits to the applicant, each one of them is stated for the purposes of sub-paragraph 8 and sub-paragraph 8 is where you net this. Now that is one place where the government is correct when they talk about net in line 10, although it's not net payment, but it is net. And if you look at the record of the agreement that was signed by these parties, you will find there, net credit, under sub-paragraph 8 which is part of the formula. You won't find anything about gross price adjustment. You will find that we asked for an adjustment and we still maintain that we are entitled then to all items that -- in that make up that computation of adjustment and by 9(c) 1, these tax effects Mr. Bender says were agreed not to be treated as such tax effect.
Byron R. White: Let's suppose that they're making these adjustments on these lines from 4 to 8. Suppose that each of you have just written a check for the -- a separate check for each amount, you would have written the check for the government for 13 million and the government written checks for these other two items -- other three items to use, separate checks, now you just deliver them to each other and consequently, there wouldn't have been any net credit you would already have paid each other off. Now, the economic effect of that I suppose should be the same as this arrangement.
John W. McConnell, Jr.: Well, we say that it --
Byron R. White: Wouldn't that be true?
John W. McConnell, Jr.: We say it's one adjustment, Your Honor but --
Byron R. White: Well I know, but isn't -- wouldn't -- shouldn't it be the same that economic effect?
John W. McConnell, Jr.: If we had exchanged checks --
Byron R. White: Yes.
John W. McConnell, Jr.: -- as Your Honor says and say there hadn't been any mortgage.
Byron R. White: Yes.
John W. McConnell, Jr.: -– we would have ended up with checks totaling $20 million more than the checks we gave to the government, $20 million, that's the net. Now all we think --
Byron R. White: Yes, but the economic effects should be the same either way, shouldn't it?
John W. McConnell, Jr.: The economic effect is the same Your Honor, if you just recall that we are asking for the economic effect of a price adjustment regardless of the individual items that make it up.
Byron R. White: But if you would exchange checks -- if you had just exchanged checks, well you would have had the result of lines 1, 2, and 3, wouldn't you insofar as purchase price would have --
John W. McConnell, Jr.: No sir, not 1, 2, and 3, we would not have. We would have ended up as I stated, we may have given them a check of $13,430,431. They would have given us the check for a million 495, a check for $2 million and 686, a check for $430,000 and if it (Voice Overlap) --
Byron R. White: And then they would have had to give you a $29 million credit on the purchase price?
John W. McConnell, Jr.: Now well -- Your Honor, you didn't let me explain because there's additional check that they would have paid us. It's not here and that's the $11 million which you would get under sub-paragraph 1, as they have omitted entirely in Schedule 1, we would have gotten another $11 million check. Now that's a point that we say that brings us down and we would not have gotten $29 million, net. The difference would have not been $29 million, but we would have had another $11 million check if they don't recognize here and it's in the record. If Your Honor will simply refer to the stipulation.
Arthur J. Goldberg: [Inaudible]
John W. McConnell, Jr.: Depreciation?
Arthur J. Goldberg: Yes.
John W. McConnell, Jr.: We don't get around that Your Honor. In fact, that's a way we base our computation of 46 million and the computation of the taxes are based on that. We don't say that it did have that fact. In fact, we recognized that effect. It was put in here for this very purpose to keep one of the parties from coming back later and saying you didn't' get.
Arthur J. Goldberg: [Inaudible]
John W. McConnell, Jr.: Oh, no sir. That's not depreciation -- oh, excuse me Your Honor. This --
Arthur J. Goldberg: [Inaudible]
John W. McConnell, Jr.: I'm talking to the -- if the -- it's on -- excuse me your Honor, let me --
Arthur J. Goldberg: [Inaudible]
John W. McConnell, Jr.: On 47, that's right. So now, that's under sub-paragraph 1 of your computation. This has nothing to do with depreciation, I'm sorry I didn't make that clear. This $11 million is entirely ignored in Schedule 1 of the government, but that's the first credit to which we were entitled and it's part of the net credits under sub-paragraph 8.
Arthur J. Goldberg: [Inaudible]
John W. McConnell, Jr.: Yes sir. If you go down credit on page 47, the last item Your Honor. Credits in favor of maritime, charter hire credited them a 13 million.
Arthur J. Goldberg: [Inaudible]
John W. McConnell, Jr.: Well, it reduce as 11 million but when you add the 2 million interest, the 1 million charter hire, I'd like to ask the government where we got depreciation on those four vessels, they treated as having been owed.
Arthur J. Goldberg: [Inaudible]
John W. McConnell, Jr.: That's just one check.
Arthur J. Goldberg: [Inaudible]
John W. McConnell, Jr.: Right.
Arthur J. Goldberg: I know that [Inaudible]
John W. McConnell, Jr.: That's right.
Arthur J. Goldberg: [Inaudible]
John W. McConnell, Jr.: Oh! Well, I was answering Mr. Justice White about individual checks for each credit. That's the reason I said I wanted a check for $11 million, $2 million, $1 million and $430,000. Then I'll give them back a check for $13 million. I was just answering his point that if we gave individual checks for each item there, but the net is as shown on 47 which is a stipulation of the parties here. And in conclusion, we give effect the 9(c) 1, but we give it the effect desired and the effect that Congress intended, but we say look back in these sub-paragraphs and look for one adjustment and to get back to Mr. Justice White, we paid $26 million which is more than the statutory sales price, we're not asking of anything except what the government gave to this taxpayer after having put out $50 million, not knowing whether it ever have reduction, they pass the statute, we're simply asking for the benefits which Congress intended to give this taxpayer to put out some money, not in reliance on any price adjustment. Thank you gentlemen.


William J. Brennan, Jr.: We'll next hear No. 79-1112, Diamond v. Diehr. Whenever you're ready, Mr. Wallace. Are you ready, Mr. Wickersham? You may proceed, Mr. Wallace.
Lawrence G. Wallace: Thank you, Mr. Justice Brennan. This case is factually very similar to Parker against Flook.
William H. Rehnquist: Mr. Wallace, let me... since you've had a half-hour of argument and are going to have another half hour, I feel more at liberty to interrupt you at the very beginning. Let me ask you the same question that I did of your opponent in the prior case, do you think the patent law of 101 is different for computers than it is for other patentable objects?
Lawrence G. Wallace: I don't think it's different for computers. As I mentioned in the last case, there have been patents issued on new computer machines. This case cites examples of patents that have been issued on processes involving the use of a computer as being the prior art that anticipated everything claimed in this process other than the algorithm, the new program.
William H. Rehnquist: Incidentally, what is an algorithm?
Lawrence G. Wallace: Well, we've talked about this in the past. The Court defined it in Benson. We have given a definition in our brief in Bradley from a manual on computers. For purposes of dealing with the computer technology, we roughly equate it to a computer program, because it's a sequence of step-by-step mathematical sequences to be performed by the digital computer. Of course, it operates only in a mathematical fashion.
William H. Rehnquist: The word has a much broader application.
Lawrence G. Wallace: There is a broader definition in Webster's. We've attempted some in our brief in Bradley, to state that we're not trying to use the word in an all-embracing fashion which would extend to some valid process patents, as we understand what process patents are, but we're confining it to the solution of a sequence of mathematical steps. The program is a sequence of mathematical steps, which is the only thing that a digital computer can function, with respect to--
Warren E. Burger: Did Chakrabarty involve a process, a composition of matter?
Lawrence G. Wallace: --It was a claim on a composition of matter rather than a process.
Warren E. Burger: When you compose disparate elements, is that?
Lawrence G. Wallace: Well, in one sense, any machine or any composition of matter is a process. But for purposes of patent law, the two are in separate categories. Scientifically, it's true that process is involved in any of them.
Potter Stewart: But this is a machine patent in the terms of the patent law?
Lawrence G. Wallace: That was true in the preceding case. In this, the present case, the Diehr case involves a process claim. It's much closer in form--
Potter Stewart: To Flook.
Lawrence G. Wallace: --to Flook, and differs in that respect from Chakrabarty.
Potter Stewart: Now, in Flook the Court summarized its own holding by saying, very simply, "Our holding today is that a claim for an improved method of calculation even when tied to a specific end use is unpatentable subject matter under Section 101. " That's the way the Court itself summarized its holding.
Lawrence G. Wallace: That is the last sentence of Footnote 18 of the opinion.
Potter Stewart: Right.
Lawrence G. Wallace: And that is the sentence that the Court of Customs and Patent Appeals has accepted as the limit of the holding.
Potter Stewart: That's what the Court said its holding was.
Lawrence G. Wallace: Well, I understand that. What we regard as the interpretation of Section 101 that I've referred to in Flook is in the two paragraphs of the text of the Court's opinion, on pages 593 and 594 of that volume. And that is the portion of the opinion that the Court of Customs and Patent Appeals has declined to follow in analyzing subsequent cases, instead relying on this sentence that you just read, Mr. Justice, from a footnote in the opinion.
Warren E. Burger: Well, the Government thought that in the Chakrabarty arguments that the Court of Customs and Patent Appeals hadn't followed Flook but really didn't seem to have the credence to go with that.
Lawrence G. Wallace: I'm aware of what the arguments were last term in Chakrabarty. I see nothing in the Court's opinion, however, that really has much bearing on the issue in this case, Mr. Chief Justice.
Warren E. Burger: Well, what about the statement in Chakrabarty that "Flook did not announce any new principle that inventions in areas not contemplated by Congress when patent laws were enacted are per se unpatentable? "
Lawrence G. Wallace: There's no such contention before the Court in the present case by any party, but I don't see that there's much bearing here.
Warren E. Burger: Aren't you pretty close to that, your argument?
Lawrence G. Wallace: I thought what we were arguing is that this Court's interpretation of Section 101 in Flook requires an inquiry to be made in the processing of patent claims to see whether the claim of novelty inheres in a scientific principle, formula, or other aspect of what this Court has referred to as "the basic currency of technological advance. " which cannot be preempted through patent claims. And what was at issue basically in Flook, as we understand it, was whether the questions of novelty and obviousness under Sections 102 and 103 would be the only possible limitations on efforts to exclude others from the use of scientific principles and mathematical formulas. And if those were related to end uses in the patent claims and the inquiries under 102 and 103 showed them not to be obvious and to be new, then others could be excluded from using those scientific principles in relation to those particular end uses; or whether Section 101 precluded claimants from trying to exclude others from the use of these basic elements of scientific knowledge even though they have novel claims to it.
Potter Stewart: Well, I don't see... Mr. Wallace, I didn't understand that was what was at issue in Flook and I'm not sure that the Court understood it that way. As Justice Stevens has suggested by his question this morning, what Flook decided was, where the only claim of the applicant for a patent is something that's just a better method of calculating, you can do it faster on a computer than you can do it with a pencil and paper, for example, then that's not patentable subject matter under 101. Despite the dissenting opinion, the Court's opinion had nothing to do with the interrelationship of 101 and 102 and 103, did it say anything about it?
Lawrence G. Wallace: Well, it did. At the bottom of page 592 of Volume 437.
Potter Stewart: I'm not the best one in the world to say what Flook meant, because I didn't agree with it.
Lawrence G. Wallace: The Court specifically addresses this question: "Respondent argues that this approach"... namely, the Court's approach... "improperly imports into Section 1 the considerations of inventiveness which are the proper concerns of Sections 102 and 103. " "This argument is based on two fundamental misconceptions. " Then the succeeding two paragraphs are what we consider to be the heart of this Court's interpretation of Section 101 adopted in the Flook case, and which is the bone of contention here. Unless the Flook holding is to be merely a guide to the drafting of claims, obviously anyone can avoid drafting his claim so that the only thing claimed is the new formula or new scientific principle, and the Board of Patent Appeals, in order to make the holding something meaningful, has, we think, quite rightly construed it necessarily to mean that they have to analyze the claims to see whether the only thing that is novel in the claims is the scientific principle, formula, or other fundamental truth.
Potter Stewart: Well, isn't it pretty well settled that the scope of a patent is to be measured by the claims of the applicant?
Lawrence G. Wallace: Well, they do measure it by the claims but they analyze the claims in light of the prior art, and it's all part of the examination of the prior art.
Potter Stewart: The prior art has something to do with novelty and obviousness and things like that.
Lawrence G. Wallace: It does. The Patent Office makes the inquiry for Section 101, 102, and 103 purposes all in the same examination of prior art. But even if there's a claim to a novel, unobvious formula or scientific truth involved, if that's the only novelty that inheres in the claims in light of that examination of prior art, then it's not patentable subject matter under Flook. That is our understanding of Flook. Otherwise, Flook becomes nothing but a guide to the drafting of claims and scientific principles and formulas will be precluded through skillful drafting of patent claims. The reason we brought Flook to the Court in the first place was because Benson had left this question unclear and had gone strictly with the CCPA on it.
Byron R. White: Mr. Wallace, when would... when could you get a patent for a process or a machine that as one of its elements has unpatentable subject matter in it? You don't say that just because a patent, the claims of a patent include an element that's unpatentable, that there's no patent?
Lawrence G. Wallace: No. Of course, if there's novelty other than novelty in the scientific principle or fundamental truth, then, of course, it's a proper claim under 101--
Byron R. White: Well, what if there's no novelty--
Lawrence G. Wallace: --and then their question of obviousness and so forth is addressed.
Byron R. White: --Well, what if you take the elements apart and you don't find any novelty in any one claim or one element except in the unpatentable subject matter, but there's novelty in the combination? Can that--
Lawrence G. Wallace: There can be novelty in a combination that will support a patent.
Byron R. White: --You don't think either one... here you say there's neither novelty in any other element nor in the combination?
Lawrence G. Wallace: Nor in the combination. The finding is that the novelty inhered only in the program itself--
Byron R. White: It's another Flook.
Lawrence G. Wallace: --and that is our position.
Potter Stewart: Well, what, Mr. Wallace, if an applicant for a patent said... it's a machine that previously, all previous machines had used spring-wind, spring-wound mechanisms to open a gate, say. And this applicant said, the difference now in this combination is that I use gravity to do it. Would that be patentable or not?
Lawrence G. Wallace: Sounds to me as if it might not be, but it's hard for me to know--
Potter Stewart: Well, would it be... or not?
Lawrence G. Wallace: --just on the basis of that hypothetical, but gravity is not--
Potter Stewart: Everything else is the same but I've worked out a way to use gravity to do this. It used to be expensive and cumbersome--
Lawrence G. Wallace: --Well, then you say you've worked out a way, if that way is something different from the previous way--
Potter Stewart: --The difference is, it uses gravity and it used to be spring-actuated.
Lawrence G. Wallace: --But if the gravity is used in precisely the same way as the spring action and there's nothing novel except the use of the scientific principle for--
Potter Stewart: All for the same purpose: to open the gate.
Lawrence G. Wallace: --the same purpose may not be in the same way. Seems to me that that--
Potter Stewart: Would that be patentable or not under your argument?
Lawrence G. Wallace: --It would depend on the answer to whether it was being used in the same way as the spring. If it were it would not be patentable, and if it were not, it would be patentable subject matter. I think that is the basic meaning of Flook, that there has to be some novelty other than a novel scientific principle. And indeed, there can be a valid claim under Section 101 even if the scientific principle is not novel, but if a conventional scientific principle is used in a novel way. The Court recognized that in the opinion of Flook. It happened that it was a novel scientific principle in Flook.
William H. Rehnquist: Does that distinction make any rational sense at all, to say that a known scientific principle can be patented but an unknown one can't be?
Lawrence G. Wallace: No, it isn't the principle that can be patented, it's only the new use of it. I mean, most inventions involve new use of familiar substances, principles, or ways of going about things, where it's building on existing technology. The effort in Flook was to prevent the patent system from being used to preempt others from using the scientific principles, even for particular end uses. And that's what I thought was the prevailing view in this Court in deciding the case and explaining the basis for its decision.
Warren E. Burger: Mr. Wallace, there are some writers who purport to be authorities on the subject who said that what the central element of Flook was that when the courts are dealing with areas not foreseen by Congress, the Court should go very slowly and that was reiterated in Chakrabarty. What do you have to say about that?
Lawrence G. Wallace: That is not our position. I can't really be responsible for what other writers might have to say about Flook. Our position is the one stated in our briefs and in the course of our argument, that Flook involved an interpretation of Section 101 of the patent laws which Congress is free to change if Congress is dissatisfied with it, and I think that under its established jurisprudence the Members of this Court should adhere to that interpretation until Congress sees fit to change it. The interpretation is laid out on the pages of the United States reports.
Warren E. Burger: Then Chakrabarty was a dubious holding under your present view?
Lawrence G. Wallace: I don't see that Chakrabarty undertook to repudiate that interpretation of Section 101, Mr. Chief Justice. I understand that the Government argued for a contrary result in Chakrabarty, but I think that the result reached in Chakrabarty is entirely consistent with the Court's interpretation of Section 101 in Flook--
Byron R. White: Well, is the end result of the Government's position that no computer program is patentable? That isn't... this Court has said that--
Lawrence G. Wallace: --Well, the program's been--
Byron R. White: --has so far said that it wasn't holding that, but your result sounds like you suggest that should be the new result.
Lawrence G. Wallace: --We refer to the prior art here, the Gould and Davis patent referred to on pages 8 and 9 of our brief in this case. Those patents described a similar process to the one claimed here and as we mention on page 9, suggested using a computer device to determine the state of cure. That was a novel process on which a patent was issued and there are many novel processes involving the use of computers on which patents do issue and patents can be valid. We're not saying that the use of a computer in a process means that the process is not a patentable process under 101.
Byron R. White: No, but... I understand that but you are now answering a different question than I asked you.
Lawrence G. Wallace: Well, the computer program itself would not be patentable.
Byron R. White: Nor any other computer program that you can think of?
Lawrence G. Wallace: For a digital computer, that is correct, because it involves a sequence of mathematical steps.
William H. Rehnquist: Whether it was described as a machine patent or a process patent?
Lawrence G. Wallace: Whether the program was described either way, that is correct, Mr. Justice. Computer machines are patentable, novel machines. And indeed the Coulter machine in the preceding case was patented and is the basis for the Honeywell computer that's being manufactured. The question is whether adding a program to it results in another patentable machine, which in effect would extend the life of the patent as we see it. I don't want to argue the preceding case, but we're not taking the position that either processes or machines are not patentable simply because computers are involved. That's a distortion of our position that's raised by some of the amicus briefs. It obviously is not our position. I think I've made clear our understanding of what the Court accomplished in Flook and the reason why Flook was here. The dissenting opinion in Flook, as a matter of fact, concluded with a reference to a number of pre-Flook decisions of the Court of Customs and Patent Appeals interpreting Benson and referred to those as presenting the same basic issue. In looking at those cases again and comparing them with the present opinion and other post-Flook opinions of that court, the striking thing to us is, how little difference there is in the analysis approach an approach being used by the Court of Customs and Patent Appeals. Prior to the decision in Flook that court took the view that the holding in Benson was really limited to an effort to wholly preempt a mathematical formula. The same basic analysis has been used in subsequent cases, although the Court does recognize that under Flook if the claim is on the mathematical formula, even though it may not wholly preempt it because it's limited to particular end uses then Flook does have to control that kind of case. But the kind of analysis described in the portions of the Court's opinion that I've referred to in detail here, when it's used by the Board of Appeals, as we think it should be under this Court's decision, has been criticized by the Court of Customs and Patent Appeals and they have really limited the holding to those two basic propositions, that if the claim is of a mathematical formula or would wholly preempt a mathematical formula, then those decisions would preclude the granting of a patent. Otherwise the analysis should proceed the way it did in the pre-Flook cases. And that is what we seek clarification of in bringing these cases here today, because our understanding of the Court's interpretation of Section 101 in Flook and what we were asking the Court to do in Flook is quite different from that. And the way the Patent Office has been administering Flook is quite different from that. I think I'd like to reserve--
John Paul Stevens: Well, before you sit down, let me just ask a question about the difference between this case and Flook. Flook suggested that the analysis would proceed by assuming that the formula was in the prior art or was well known and then looking for something else that was claimed to have been discovered. Here everybody agrees that the formula for figuring out how long to cure the rubber was well known. The... I forget the name of the formula... but that was well known. As I understand it, the claim is that it was a new idea to realize that a computer could make use of this well-known formula when it was attached to measuring devices within the oven and cause this desired result to occur. I suppose they're claiming that discovery of the fact that a computer and the appropriate program will do something that could be figured out before is itself proper ground for getting a patent, which is a little bit different than the issue in Flook.
Lawrence G. Wallace: --To the extent that was the claim, the Davis and Gould application referred to on page 9 of our brief had described the use of a computer to do this similar thing. And what the Board found here to be the contribution, to be the novel thing, was the devising of the computer program. Both the Board and the Court of Customs and Patent Appeals agreed that the application indeed disclosed a computer program. The Board found that to be the only contribution, the only novel thing in light of the prior art in this application. The Court of Customs and Patent Appeals refused to pass on that question because it thought that inquiry was beside the point.
John Paul Stevens: As a case involving the creation of a new computer program to implement a well-known formula.
Lawrence G. Wallace: That is what this case--
John Paul Stevens: That's what you'd--
Lawrence G. Wallace: --Yes; in a conventional process. It's programming a computer so that the computer can be used in a conventional process to implement a known formula, and using the conventional way of programming a digital computer, which is a sequence of mathematical steps. I'd like to reserve the balance of my time.
Warren E. Burger: Mr. Wickersham.
Robert E. Wickersham: Mr. Chief Justice, and may it please the Court: The case does indeed involve the statutory construction of Section 101 and the word "process" and we're all agreed on that. Both Gottschalk v. Benson and Parker v. Flook make it clear that one index of having a process which is patentable subject matter is the transformation of state, changing something from one thing to quite another thing. Now, this messy, circular piece of uncured synthetic rubber is our starting material, or one of the starting materials. I don't know that you can use it for anything except to make something else out of it.
Potter Stewart: You're using it very effectively.
Robert E. Wickersham: This is the resultant... thank you, Judge... this is the product as it comes out to the mold, bonded to a metal ring and changed permanently, both chemically and physically to an entirely different shape which it will hold, and to a chemical state that will enable it to obtain the desired rigidity and other characteristics so that it will operate. This particular device is used as an oil seal or shaft seal to prevent oil from running out of a railroad roller bearing and thereby having the bearing burn up and stop the whole train.
Warren E. Burger: Well, it has other uses too, I take it?
Robert E. Wickersham: Here is a small one, a piece of "prets", still substantially useless. And here is the precision product made from it. This one has been trimmed, the other one had not. This is used on an automobile. And those of you who have had to replace a transmission due to a faulty oil seal or perhaps a wheel bearing or something will bear in mind that this is an important use of the product. This is what my client mainly makes. It does make some other products, such as O-rings, which are used in some other places. But basically the process that we're involved with, and the whole purpose of the process, is to change this floppy, rather useless material as it stands, into a completely different state or thing. And that is done by a process known as molding under pressure with heat. The fact is that chemicals can often change from one chemical to another just by the application of heat. That is what we are getting here. Technically it's called cross-linking. But the fact is that when we come to cure it we run into problems, and our problem was that curing became mainly a matter of guesswork. We have this equation, it's called the Arrhenius equation. I don't expect you necessarily to remember the name. He was a distinguished Swedish chemist and he received the Nobel prize, not for the equation, perhaps, but for his work, and this was one of the good fruits of his work. It's admittedly very old. We could use that before, and we could calculate with or without a computer or calculator how long we thought it would take to cure. But we really didn't know what temperature the mold was at. We heat the mold but molds have to be opened to put the material into them. So we'd open the mold and the operators would take different times to fill the mold. A typical cavity might have 64 or 128 cavities, all to be filled. It might have somewhat fewer. You close the mold and start the time going. It may be at a different temperature from one operation to another. A thermostat... there are two thermostats are on the machine, and when it reaches a certain critical temperature, the upper end of the temperature-curing range, the thermostat cuts it off and it begins to cool again until it reaches the thermostat at the lower end of the range and then heat comes on again, and it goes on and off, and on and off, during the curing process. But what temperature is the material at in the mold? Well, we don't know unless we actually find some way of measuring it in the mold. And when we do, we find that it's at different temperatures at different times. Now, the thing that this invention found as a use for a digital computer is that combining that with a constant temperature monitoring located in the mold, but not at the cavity, but near the cavity, would enable us to get readings often... well, constantly, in fact, and to calculate them segment by segment all through. So when the mold's warming up, it's being calculated. That time doesn't result in very much cure but it has some and we know what it was at. When it gets up into the range it's calculated each time at the temperature that it is now. And this constant reading of the temperature by a, in a means that will not injure the product combined with the constant recalculation, not just a calculation... because if we got just one calculation, we wouldn't be any better off than we were before, to enable us to get a better product--
Harry A. Blackmun: Would you help me out at this point?
Robert E. Wickersham: --Yes, Mr. Justice Blackmun?
Harry A. Blackmun: What is the difference between your claimed method for updating cure time, so to speak, and the method for updating the alarm limits held unpatentable in Flook?
Robert E. Wickersham: Well, there are quite a few differences in there. The first is that our claimed method is a claim for a process for molding a precision synthetic rubber product, whereas, as noted in the majority opinion particularly the alarm limit is a number and the claim was directed in that, to calculating a number and then by some means or other which could have been manual simply resetting the alarm, which is a post-solution step. In that case the only novelty was said to be the equation. In our case the equation is certainly not novel. We contend that the combination has been held novel by the examiner since he withdrew his 103 rejection on the grounds of obviousness, and he never did make a 102 rejection showing that he didn't believe that there was any lack of novelty in our case. Does that answer the question, Mr. Justice Blackmun? I don't want to answer something you didn't ask, instead.
Harry A. Blackmun: Well, that's an answer. I don't know whether it satisfies me, but it's an answer.
Robert E. Wickersham: Very good; all right.
Harry A. Blackmun: I am having difficulty distinguishing this case from what the Court held in Flook.
Robert E. Wickersham: I see. Well, I have... I feel I have very little difficulty in doing that, because, in the first place, we have a process that really changes a material object. They didn't have that. You see, we're not claiming a number. And we're not manufacturing numbers. We're not manufacturing digits or binary coded decimal digits or a mathematical calculation.
Byron R. White: Well, what's new about your process? You told us that it's an old idea to cure this, so what's the... apparently there's some novelty in the use of the computer or not?
Robert E. Wickersham: Although novelty is not supposed to be a question--
Byron R. White: I understand.
Robert E. Wickersham: --on a 101 issue, I'll certainly tell you. The novelty in it, which resides in the invention as a whole, is the combination of constant temperature reading at a place where it will not injure the product, combined with constant recalculation.
Byron R. White: Using the computer?
Robert E. Wickersham: Using the computer. Oh, there's no other way to do that good calculation that I know of. I mean, you could get a mathematical genius to do it mentally; it wouldn't help the novelty of the case any.
Byron R. White: But if the only novel element in here was the use of the computer?
Robert E. Wickersham: Well, Mr. Justice White, if that was it, I don't think I'd have gotten this far.
Byron R. White: No, you certainly wouldn't. You wouldn't be here, would you?
Robert E. Wickersham: I wouldn't.
John Paul Stevens: Mr. Wickersham, isn't it true that the process was all well known except the problem of knowing when to stop cooking? When to open the oven?
Robert E. Wickersham: Not exactly, Mr. Justice Stevens. The problem in the sense of knowing that you wanted to get an exact cure and knowing that if you knew the time when you had an exact cure you could open it, that certainly, that part of it was known. But up to this time the recalculation at frequent intervals was not at least made use of, so far as I can tell. Of course, that's more of a novelty--
John Paul Stevens: No, I understand that, but what the recalculation at frequent intervals does is tell you the precise moment when you should discontinue the curing process.
Robert E. Wickersham: --That is true.
John Paul Stevens: Which in effect could be described as a number, because it's a certain number of minutes or seconds from the time you started the cooking.
Robert E. Wickersham: I don't think we ever know the number; we know the product.
John Paul Stevens: They didn't in Parker against Flook either, until they got... they kept updating it and it's a constantly changing number. But this is also a number that you don't know of until you get there, until these two factors coincide. Isn't that right?
Robert E. Wickersham: It could be expressed as a number, Mr. Justice Stevens. Actually, I don't believe in our process that we ever bother with what the number is.
John Paul Stevens: I understand.
Robert E. Wickersham: Once our prime time is reached, the mold opens, it's done, and we take the thing out before it overcures. Of course, earthquakes can be expressed as numbers but they're not numbers.
John Paul Stevens: Is it correct that if you had all the monitoring devices and they transmitted the temperature and time onto a screen, constantly changing so that you could always look at it, and you had a mathematical genius who could do this formula in a second or two, you wouldn't need the computer?
Robert E. Wickersham: That's true, that's true. They might cost more than the computer these days, but that's true.
William H. Rehnquist: I understand. Well, don't most inventors begin their inventing work trying to solve a particular problem rather than just sitting down and saying, what will I invent today?
Robert E. Wickersham: Mr. Justice Rehnquist, you are completely right. Very few inventors just think about what they want to invent. Some do, but very few. And this was made to solve a problem. As you may have noticed, we've made more than $400 million worth of these products since we did it and it saved us about $25 million, which isn't bad. The problem that we had, for one thing, was that by, when we overcured, as we had to do if we were going to make sure it was not undercured, that we tied up all our machines. And so we've been able to increase production perhaps by ten percent at least, I understand, maybe more than that. It's not quite clear, but the idea is, we've gotten much better products and we can produce more of them in the same time from the same machines. I think that's a very substantial indication that there's something here that would be patentable.
Potter Stewart: Well, that's an indication of utility.
Robert E. Wickersham: It is, it is. It's an indication also that if you could do it beforehand you'd have done it beforehand.
John Paul Stevens: Well, that's what utility is. Mr. Wickersham, if one of your competitors were to hire the mathematical genius I described, would they be infringing?
Robert E. Wickersham: I don't think they would, the way our claims are worded, but it would be an interesting case. I think, as you'll notice, our claims as stated, except for Claim 11, the presence or the digital computer, because we thought that was the practical way to do it. Remember, we didn't know that Flook was going to be decided when we wrote these claims. We weren't aware of what the Court was going to do in that kind of thing, and the claims, I hope, are somewhat artfully drawn from the sense of patent law, because that's supposed to be my profession. But they're not artfully drawn to get around any particular decision anywhere.
John Paul Stevens: No, and you make the assumption that Flook mandates, namely, that the mathematical formula is one to be assumed to be well-known, and here, in fact, it was.
Robert E. Wickersham: Well, as far as I'm concerned, of course, we couldn't assume anything else here. It definitely was old anyway, whether we would assume it or not. With us, the point was to put these process elements together. Process elements are somewhat different from machine elements, but the operation is basically the same. If we had the computer and didn't monitor the temperature the way we did or didn't use it for frequent recalculation, then we wouldn't have the same thing. I believe I should touch a little on the point that the Solicitor General brought up, that of some prior art and things. As I understand it, the Section 101 issue is to be decided before one goes into the prior art and there's a sentence in the case of Parker v. Flook that says so, as to the art that he is using, the Gates and Davis patents. I should point out that the examiner had considered them and withdrawn his Section 103 objection over them, and that should indicate that at least to one experienced man it was not an obvious thing to do. Part of the difference in those resided in the product, of course. In both those patents they're talking about making rubber tires, which are rather huge things and what we would not call, in our particular field, a precision-molded product. You can see on the rubber tires when you get a new one all the flash, the extra material that's there. You can see that although it has a certain definition and such, it's still relatively a crude product, at least compared to what we have. We could not stick a probe through our material without completely ruining it. We couldn't even have capacitance measuring devices going across it starting from the mold without a great deal of difficulty in trying to get a product out of it that would be a satisfactory product. It would be too rough. It would have these bumps on it. As far as I'm concerned, both the majority and the minority in the Flook case seem to have agreed that Section 101 does not call for considering Section 102 or Section 103. That is the exact conclusion to which the Court of Customs and Patent Appeals came and why the Court of Customs and Patent Appeals didn't disturb, so-called, the findings, so-called, of the Patent Office Board of Appeals.
Byron R. White: Suppose the claims of a patent clearly encompass some unpatentable subject matter and it's completely agreed that that unpatentable subject matter is a discovery in the sense that it's new and novel, but didn't Flook suggest or hold that if that's the only thing new or novel in the claims, that there is no patentable issue?
Robert E. Wickersham: I think it suggested or held that; I do.
Byron R. White: Well, then, mustn't you, if you find an unpatentable element in the claims, mustn't you inquire whether there's something else that would entitle you to a patent in the claims?
Robert E. Wickersham: I think that basically, of course, you're right. I'm not going to argue with you.
Byron R. White: And in that sense... well, in that sense, then, you do inquire into these other elements?
Robert E. Wickersham: In that sense and that sense alone, yes.
Byron R. White: Well, all right, but don't say then that those elements are wholly foreign under Flook.
Robert E. Wickersham: Well, the Section 102 and 103 considerations go much deeper than that, I believe.
Byron R. White: Well, it may be, but they--
Robert E. Wickersham: Well, Congress at any rate thought they were separate and said that they'd split the statute in two. The Section 101 covered basically the classes of things which could be patented, Section 102 covered the novelty, and Section 103 the question of obviousness. And I think basically that's what's intended. I would say... you asked a question about types of inventions that do not come under Section 101. There are many, many such. Methods of doing business, for example; sales programs; the ideas for books, or plots. You can enumerate them forever. There's many things that don't come under Section 1. Basically, Section 101, I believe, was intended to protect inventors who came up with something of a physical embodiment, some way or other; at least a physical embodiment. Now, numbers are not really physically embodied even when we write them out, as digits, in the Arabic system. That's simply a symbol. The number itself is still a concept. And I don't think it was ever intended by any of the writers of the Constitution or the legislators in Congress, at any time, that people be able to patent their concepts. But when it gets down to having something that can be reduced to a physical status, whether it's a composition of matter as it was in Chakrabarty, under one interpretation anyway; process is under another, whether it's a machine or whether it's some sort of article that you can sell, any of those things, I think, certainly justify a patent as far as Section 101 is concerned. As far as Sections 102 and 103 are concerned, examination is pretty strict at the Patent Office. The product that we have here, for example, this little thing here, has at least two patents that cover it as a product, because there were two inventive concepts that were then physically embodied. That doesn't count the process. We make other things that aren't patentable, or patented by our process. I hope that we've arrived at most of the question because I certainly want to take care of any questions that you have while I'm here.
John Paul Stevens: --Do you think the issues in these two cases are pretty much the same, or different?
Robert E. Wickersham: These two cases?
John Paul Stevens: Yes--
Robert E. Wickersham: I would say they're quite different. I'm not trying to get anything on a machine, they're not trying to get anything on a process. They impressed me that the only thing they really have in common is the use of Section 101 and the contention by the Commissioner that they both involve computer programs. By the way, here's a computer program, some 300 pages, which is used in this process. We didn't disclose it in the patent application because it wasn't necessary, but that is a printout of the program. The actual program are the instructions, of course, that go into the machines in the computer. We're not trying to patent that. We don't want to patent it, even if we could, I couldn't write a claim 300 pages long to cover it.
John Paul Stevens: --You want to patent the idea of using that program or one like it to figure out how long to cook the rubber?
Robert E. Wickersham: Well, any computer is useless without some program, once you get... that is, except as an object to sell or something of that nature. And so it's going to be programmed some way or other. But the specific programming will depend on the rubber that you're going to use, the kind of mold you're using, its shape, and all that. Now, we have this, because this controls, in effect, the whole plant. We can use one computer to control 60 machines and do it, in the same plant. So that we are able to get a lot of mileage out of the computer, but we don't make computers and we don't usually come up with computer programs. We usually simply make oil seals, shaft seals, rings of that kind, and then other products that aren't related at all to this invention. What we're interested in protecting is that. We're interested in being able to keep our competitors from using it without a license from us. We're not interest at all in protecting the program. The flow sheets that the Government contends are the program are... well, they certainly tell a lot about the program, they enable someone to use it. But that's going to be printed in the patent; we don't care if it's printed in the newspapers. We don't care if it's distributed to everybody in our business. They can put it into their computers if they want to as long as they don't make these rubber products. The case, to me, is an important one from the stand-point of patent law because up until a short time ago when the Solicitor made his statement toward the end of his argument, I believed that they were trying to say that the use of a computer in any way, or program, made the whole process unpatentable no matter what it was. I found out he doesn't make that contention and I'm very much relieved by it.
Byron R. White: But he does apparently claim that no computer program is patentable.
Robert E. Wickersham: He does; yes. Now, as far as I'm concerned, I've never given it much thought whether a computer program is patentable because computer programs are so long, so unwieldy, that I just can't see anybody applying for a patent on it. That may not be the thoughts of people in the software industry but I don't have any clients in that field myself.
Speaker: What about a copyright?
Robert E. Wickersham: Well, that's another interesting idea. Of course, that wouldn't protect us at all. We're trying to protect our rubber molding product and you can't copyright that kind of thing. That's up to Congress right now and I hope they can work out something that will be for the best of the country, whatever it is. Are there any further questions?
Warren E. Burger: I think not.
Robert E. Wickersham: I'm really basically finished.
Warren E. Burger: Very well.
Robert E. Wickersham: I'll be happy to continue if you want, a little at a time. Thank you, then.
Warren E. Burger: No requirements. Do you have something further, Mr. Wallace?
Lawrence G. Wallace: Please, Mr. Chief Justice.
Warren E. Burger: Six minutes remaining.
Lawrence G. Wallace: I'll try to be brief. We recognize that the process described in detail in respondents' brief and described during the oral argument is a useful technological process, as indeed was the process of updating the alarm limits in Flook for the purpose of producing certain petrochemicals and other use in the hydrocarbon industry, not just to use to get a number, after all. But it was being applied to the manufacturing processes of catalytic conversion. And, indeed, there is a patent on basically the same process that has been described in so much detail, that is the Gould and Davis patent which was cited by the examiner as the prior art. And in comparing this application with the prior art, the determination was made that what was disclosed here was a computer program and that everything else in the application was conventional, was known in the prior art, was the familiar process.
William H. Rehnquist: Well, do you think the Gould and Davis patent was a good patent?
Lawrence G. Wallace: We have no reason to think otherwise. It was issued by the Patent Office. It has not been challenged in infringement litigation. We think processes of this kind can be patentable. It probably was a good patent.
Speaker: Well, whether it was a good patent or not, it was known.
Lawrence G. Wallace: It was known; that's right. Whether it was prior art doesn't depend on whether it was a valid patent. It was prior art. Now, the fact of the matter is, regardless of whatever factual contentions are made here about whether all of the novelty inhered in the computer program, we've tried to answer those in our brief. That was the finding of the Board, not disturbed by the Court of Customs and Patent Appeals. The fact of the matter is, computer programs can be novel and not obvious. And the question that the Patent Office has been faced with, the question that was before this Court in Benson and again in Flook, is whether there's any limitation in the patent law on awarding the patents when you have a computer program or other sequence of mathematical or scientific steps that is novel and not obvious, and there's an attempt being made to exclude others from using it, perhaps for particular end uses. And I want to remind the Court that in the Benson case the Court quoted from the President's Commission on the patent system, which said that the programs themselves were nor statutory subject matter, and, then, the indirect attempts to obtain patents by drafting claims as a process or a machine or components thereof, programmed in a given manner rather than as a program itself, should not be permitted. And the reasons why that Commission said they should not be permitted were that reliable searches would not be feasible or economic because of the tremendous volume of prior art being generated. Without this search the patenting of programs would be tantamount to mere registration, and the presumption of validity would be all but nonexistent. And the creation of programs has undergone substantial and satisfactory growth in the absence of patent protection and in the meantime copyright protection for programs is available. That is the legislative question that this Court has twice said it is up to Congress to address, whether in whatever form and effort to get patents on processes or machines where the only element of novelty is in the computer program should be permissible, as long as those programs are not obvious or novel.
John Paul Stevens: May I ask you a question that's really unrelated to this legislative problem? Supposing the Gould patent in this case had never issued but was just applied for, and it had whatever claims it has in it now, 13 or 14 claims. And there was a claim 15 that said that everything in the preceding claims except that all the mathematical calculations shall be performed by means of a digital computer, would the entire patent application be patentable subject matter, and or if all but the last claim would, would the last claim not be patentable subject matter because of the reference I include in it?
Lawrence G. Wallace: Well, the mere suggestion of the use of a digital computer would not make the application unpatentable. Actually they did suggest the use of a digital computer.
John Paul Stevens: What's puzzling about this case is, you rely on the earlier patent application to demonstrate that there is no novelty in much of this process, but they argue, they come back and say, yes but that does demonstrate that the process is patentable subject matter, because a patent issued on it. And the only thing that's happened is, they've added something in here. Does that destroy what would otherwise be patentable subject matter simply because they say you can do a lot of the operations in the process by having the mathematics done by a computer instead of a genius?
Lawrence G. Wallace: This is true of a process application or a machine application. The prior art shows that patents do issue for processes and for machines, and if Flook is to mean anything, it must be more than a guide to the drafting of these claims, so that there's always a claim beyond the novel formula itself in the application. It must mean that the application is analyzed to see whether the only novelty inheres in the scientific principle or formula. And that is our point, in bringing these cases to the Court.
John Paul Stevens: And what you'd say to my hypothetical is that last claim would then be rejected because the only thing that was additional in that is the use of the computer, which would not make it patentable?
Lawrence G. Wallace: It could be rejected just as the one claim in Morse was rejected, that the Court referred to in Flook.
Warren E. Burger: Thank you, gentlemen. The case is submitted.