Risk Management Society Publishing

February 1, 2001

Intellectual Property at Risk

By: Judith Pearson

We have arrived at the intersection of a changing legal and business environment. Intellectual property (IP) exposure is at the center of the crossroads; litigation over IP rights has catastrophic potential.

Intellectual property--defined as any intangible asset that consists of human knowledge and ideas--has become a valuable and costly enterprise. The average cost to litigate a patent case today is $ 2.5 million, and each year that increases 10 percent to 15 percent. In light of the amounts at stake, law firms and plaintiffs treat IP litigation as a growth industry.

Why the change now? Dramatic technological developments have created new wealth for shareholders. More than ever before, sophisticated investors are placing value on intellectual property and corporate management strategies. Moreover, corporations are changing the way they manage their intellectual property portfolios. Intellectual property is now viewed as a way to strengthen earnings, shore up the value of assets and provide growth in varying economic climates. While companies cannot afford to lose their intellectual property in court, aggressive firms are poised to succeed in forcing just that.

Why Me?

Company leaders sit back in their chairs and ask: "We do not have patents, so how big can our risk be?" The answer: enormous.

While patents drive 60 percent of the current intellectual property litigation, trademarks and copyrights represent another 34 percent. More worrisome is trade secret litigation. While it currently represents just 5 percent of the cases filed, trade secret litigation will ultimately mirror both the frequency and severity of patent litigation as the importance and exposure of trade secrets expand.

Another common misconception is that the rise of intellectual property litigation is focused on hi-tech or Internet-based companies. While it is true that a significant number of cases involve these areas, much of the litigation is also challenging court positions on the patent-ability of software and business processes. Although litigation against companies in software, hardware, semiconductor and Internet businesses represent 39 percent of the litigation, traditional manufacturing companies are involved in more than 35 percent of the activity. Consider also the effect of globalization for any company.
Intellectual property issues are a focal point in many trade negotiations. And in 1999, only 58 percent of all U.S. patents were issued to domestic companies; the remaining were registered to foreign entities--with companies in Japan,
Germany and France leading the way. Corresponding statistics from other clearinghouses, such as the World Intellectual Property Organization, provide similar views of the intellectual property landscape. Industry mores are changing--and no sector is secure.

The size of a company is also not necessarily a good indicator of exposure. According to Aon, approximately 13 percent of the thirty-three court cases it tracked were filed against companies with assets of less than $ 100 million, while 32 percent were against companies with assets in excess of $ 1 billion. (Total estimated losses in these cases is estimated to be in excess of $100 million.) It does not matter if your company is large or small, public or private--all companies are exposed.

Idea Management

Because of the evolving risks to corporations, qualifying and quantifying corporate exposure are key components to risk management techniques. The evolution of intellectual property risk factors is analogous to the changes directors and officers faced in the early 1980s. Prior to the merger mania of that decade, shareholders rarely challenged the behavior of the board of directors. The extensive litigation beginning in the late 1970s and early 1980s clarified the relationship of the shareholder to the board of directors and established the foundation of best practices.

Today, through the rise in litigation, standards in intellectual property management are being forged.

The process begins by investigating your company's nature and attitudes regarding intellectual property: what is management's view of intellectual property?

* Is your company currently operating in a defensive or aggressive mode?

* Is your company typically a leader or a follower in its industry?

* What are the current industry mores? Are they changing?

* What has been the impetus for change?

* What has been your company's position on IP and litigation to date?

Answering these questions will help you set best practices particular to your company's needs, and allow you to tackle the business processes that pose the greatest risk for IP.

Business Transactions

Transactions present a potential minefield of IP loss and litigation, particularly mergers and acquisitions. Intellectual capital drives some part of almost all acquisitions, yet due diligence teams often fail to address this during the analysis phase.

Intellectual capital encumbered by lawsuits or exposure will significantly reduce the return on investment. An initial public offering (IPO) is another threat. It increases the visibility of the business, and thereby initiates increased scrutiny of the underlying products and technology.

In an expansion phase, corporations face significant potential litigation in geographic, business or product line augmentation. For example, the Kellogg's v. Exxon case demonstrates how two companies can coexist for thirty years until business expansion creates a rift. The case revolved around Exxon remaking its "tiger in your tank" trademark into a "friendly tiger" when it entered the food market business. Kellogg's argued that the business expansion and friendlier tiger created confusion with its advertising icon, "Tony the Tiger."

Companies need to examine licensing arrangements, partnerships, joint ventures and other investments with an eye to the management of intellectual property. Often there is a disconnect between the authors of the agreements regarding business goals. The authors typically either have an intellectual property background or expertise in drafting contracts, but formal relationships need drafting expertise from both practices. Otherwise, the ownership and ultimate use of the intellectual property, such as the right to license codeveloped technology, become fodder for future litigation.

Drifting Employees

Beyond corporate transactions, with the U.S. unemployment rate at a record low, employee disloyalty is at a record high, creating yet another vulnerability to litigation. As key employees become transient and bring corporate trade secrets with them to new jobs, trade secret litigation will ultimately mimic patent litigation in terms of both frequency and severity.

The key to protection is identifying, cataloging and tracking the evolution of the ideas and educating employees about the current legal environment. Yet even with these efforts, companies that are feeling the staffing deficit, especially those hiring people with computer expertise or other such high demand skills, cannot secure typical protections during the employment process, leaving the door open for litigation.

Bring It to the Top

Because intellectual property exposure is still developing, traditional insurance risk management roles and techniques require continuous refinement.
This is a corporate management problem; you should be discussing loss prevention and mitigation techniques both within your department and with your firm's senior management.

The changing case law and history of precedent-setting decisions have created a critical need for broad access to the newest techniques. Although the majority of companies have adequate practices in some areas, gaps in other areas still create significant exposure. Once your organization has completed a risk qualification and quantification process, the company is in a position to design a risk management program suitable for its needs.

The tools have evolved to provide a sophisticated approach to a comprehensive risk management strategy. Corporate risk management must take the lead in examining the risks inherent in the firm's intellectual property-before the competition identifies and capitalizes on potential weaknesses.

The IP PI

Let's say you are the risk manager at the Blueshift company, a mover and shaker in the wonderful world of widgets. The wizards in the marketing department decide that the latest, greatest widget Blueshift has produced should be called the "Butterflydog." The first thing that you have to do, before you can actually trademark Butterflydog, is search the government's database and see if anybody else has trademarked the name for a widget. Sounds simple, but it is not.

Since trademarks are divided into many different classes, there might already be a trademark for Butterflydog, but it might be for a frisbee or a flower. You might still be able to trademark it even though the name is already in the government database, but how can you be sure? The last thing you want to do is launch your new product and get slapped with a lawsuit. What you do is bring in a white collar gumshoe like Kessler Associates.

"We're investigative consultants and forensic accountants," says Michael Kessler, head of the company's worldwide operation. "Seventy-five percent of our work involves intellectual property matters. That includes light royalty audits for licenses, protection of trademarks, illegal use of trademarks, antidiversion and anticounterfeiting."

Kessler's duties vary depending on the specific needs of the clients, which include many Fortune 500 companies. His staff check trademarks for present and prior use. This kind of work is becoming a mainstay of their business, especially as the Internet explosion erases geographic boundaries.

"With the emergence of licensing now in Europe," says Kessler, "we are conducting more licensing types of investigations and audits. Licensing is fairly new to Europe, so the kind of work we do is in high demand across the Atlantic. Meanwhile, here in United States, where the licensing of a product has been around for years, the-meaning of the term has expanded, What you never used to think of as a licensed product has now become one."

Using advanced software programs, they scan the trade boards on the Internet. But it is not all desk jockeying; they also do a lot of footwork. "We go out and if someone is using it (a item that is already trademarked), we try to get samples of it. We try to determine when it was first used. Then we go back to the office and scour the media with software that allows access to newspapers and magazines all over the world. We pick up any info we can--press releases are especially useful--for finding first use dates. If it's out there and discoverable, we can find it for you."

Stephen Nickson

Defending Your Name

What is in a name? Recognition and reputation. What is at stake? The very future of your company. That is why the business of protecting your name (or intellectual property) from e-terrorism has never been more complicated or more important.

Cybersquatters are the most prominent danger. Cybersquatting is defined as registering, trafficking in or using domain names (Internet addresses) that are identical or confusingly similar to trademarks with the bad faith intent to profit from the goodwill of trademarks. The squatter often tries to sell back the domain name to the owner of the trademark at an extremely inflated price (registering a domain the Internet usually costs between $ 5 and $ 35 a year). Big name celebrities and corporations will often find their name is already owned by someone else.

This form of piracy, once rampant, is fading into the pixellated background. In 1999, Congress passed the Anticybersquatting Consumer Protection Act (ACPA), making this form of extortion a far less profitable proposition for cyberthieves. Still, defending your turf could be a long and costly battle. It is often cheaper to buy off squatters than have them legally removed, which is why the World Intellectual Property Organization (WIPO) proposed a better solution. At WIPO's suggestion, the Internet Corporation for Assigned Names and
Numbers (ICANN) agreed to require anyone registering a domain name to agree to dispute resolution should an argument arise. Because compliance is mandatory, this dispute resolution policy simplifies the process. Disputes are arbitrated for a relatively fee (around $ 1,500) by a committee of experts. This presents a clear risk to the cybersquatter, effectively curtailing the danger to your business.

Beyond extortion, cyberpirates can use familiar names to divert traffic from intended destinations or to sell competing products. While these abuses are illegal under the ACPA, other abuses, including parody sites, protest sites and hate sites land on a more slippery slope. These domains could pose a serious threat to your business. Take Walmartsucks.com. This highly critical site includes complaints and news articles in addition to airing dirty laundry that uses the names of Wal-Mart's upper-echelon management. Everyone has the right to express their opinion, but can they get away with using your trademarked name?
Right now, they can.

Protecting your company from cybervillainy is further complicated by several factors. The dispute resolution policy is not applicable to foreign countries, many of which have their own suffixes (.fr for France, .it for Italy, etc.). Wrestling your name away from foreign ownership could be a real hassle. (Can you spell your company's name in Japanese? Plans are underway to incorporate alphabets that are not Roman/Arabic into dot-com territory.) There will also be times when a number of parties have a legitimate right to the same name. You will have to decide how far you want to go, what chance you have of winning your name and whether it is even worth it. David Bernstein, a partner in the intellectual property practice group Debevoise & Plimpton notes in a Knowledge@Wharton article, "If someone puts up pentium.net and is selling competing chips then you go after them in court because it's trademark infringement, not cybersquatting. But if someone puts up pentium.net and it's their dog's name, who cares?"

Now think about everything that can come between your name and .com. Each major product line may need its own domain name (ikeabed.com, ikeadesk.com, etc.). And if that is not enough, ICANN just approved seven new suffixes (.aero, .coop, .pro, .museum, .name, .biz, and .info). Trying to buy up every domain name pertinent to your company in every country and under every suffix would be exhausting, requiring not only a lot of time and money, but a lot of creativity as well.

The most important factor to be aware of is consumer behavior. Specifically, how might e-terrorism affect your consumer base? Does your company use the Internet simply to convey basic information, or does it provide tangible service to your clients? Are you actually using the Web to sell products? Is your consumer base likely to use the Internet at all? Is your business particularly susceptible to vicious criticism (be honest now, pride will get you nowhere ... except posted on a nasty Web site with donkey ears photoshopped to your picture). If your clientele is sophisticated, they, they are likely to know the difference between humor and libel, between hearsay and fact. But, remember, there is always another place to buy your product, so it is important to protect your assets. That means determining how much risk cyberpiracy poses to your company, protecting your intellectual property and defending your name.