Navigating successfully in world of risks by liaoqinmei


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 The Bottom Line of
Intellectual Property

February 3, 2005
The Bottom Line

    In today‟s knowledge-based
    economy, an entity‟s value is
    driven by its intellectual assets
    rather than by its “hard” assets.

    Entities that consider themselves to
    be successful in the management
    of their intellectual assets may not
    be fully aware of the IP risk
    management methodologies and
    solutions that can help them
    become more profitable.

Presentation Objective and Overview

    Objective: Demonstrate methodologies and approaches to manage IP risk

    • IP Primer
    • IP Statistics
    • IP risk from the risk management perspective of the business and
      financial professional, risk manager, and insurance underwriter
    • Strategies for managing IP risk and financial exposure
    • Business scenarios presenting IP risk

What Is Intellectual Property?

     Intellectual property (IP) consists of legally
     protected „creations of the mind‟                Patent

      • Patents protect useful inventions.

      • Copyrights protect creative expression
        in recorded, tangible form (including software).

      • Trademarks identify ownership of goods through symbols, marks or other words.

      • Trade secrets are any confidential information that gives you a competitive business

     An organization has IP exposure whether or not the organization itself owns any
     intellectual property.

     IP assets protect revenue (by protecting revenue-generating products) and generate
     revenue (royalties).
What Are The Elements of Trespassing On or Stealing IP? (US

       Patent Infringement (federal law)
        • Determine scope and meaning of the patent claims by construing the claims (“claim
        • Compare the elements of the patent claim with the accused device or process to
          determine if the claim “reads on” the accused device or process
       Trademark Infringement (state and federal law (enforcement structure))
        • Development of a protectable trademark right
        • Use by another of a confusingly similar mark in such a way that it creates likelihood
          of confusion, mistake and/or deception
       Copyright Infringement (state and federal law)
        • Ownership of the copyright
        • Unauthorized copying
           – Infringer had access to the work
           – The two works are substantially similar from the viewpoint of the average observer
       Trade Secret Misappropriation (state law)
        • Acquisition of a trade secret of another by a person who knows or has reason to
          know that the trade secret was acquired by improper means or
        • Disclosure or use of a trade secret of another without consent
 What is Infringement?
 Trespass = Make/use/sell/offer to sell product
 (think supply chain)

          An example of patent infringement
        - Patent “A” is granted for a chair with legs - broadest patent
        - Patent “B” is granted for a chair with four legs - less broad
        - Patent “C” is granted for a chair having 4 interconnected legs - narrow

The chair introduced into
the marketplace                                    Patent A
infringes on patents A, B
                                                  Patent B
and C.
                                                   Patent C

IP Protection in Canada

How Does Your Company View IP?

    Intellectual Property is an important asset of my company:
    • How do I get more? (Should I get rid of some of my IP?)
    • How do I protect it?
    • How do I make money from it?
    • How do I value it?
    Intellectual Property is also a very large potential exposure:
    • How do I avoid or mitigate the downside of infringing someone else’s
      intellectual property?
    • How do I avoid or mitigate liability that occurs through my business
    • How do I avoid or mitigate liability arising out of the purchase or sale of
      assets or businesses?
    • How do I control development, protection, maintenance and enforcement
IP Rewards and Risks

                       Rewards/Opportunity = in addition to protection of
                       market position, IP owners can extract value from their
       Growth of       IP rights/assets
    Patent Royalties
                       •   In 2000, annual licensing revenues reached $130 billion.
                       •   Academic institutions alone earn nearly $1 billion in gross annual
                           licensing income.

                       Risks = growth of patent royalties paid
                       •   Increased amount of IP means more IP subject to infringement.
                       •   IP infringement damage awards and settlements are increasing.
                            – Total amount awarded in the 1990s doubled the total amount awarded in the 1980s.
                            – Top five IP verdicts in 2000 totalled over $900 million.
                            – Patent damage awards typically range from $5 million-$100 million.
                            – Top patent infringement damage award in 2002 = $505 million (IGEN International,
                                Inc. v. Roche Diagnostics GmbH)
                            – Top patent infringement settlement award in 2002 = $300 million (Intergraph Corp.
                                v. Intel Corp.)
                            – In 2004, InterTrust settled its patent infringement law suit against Microsoft for $440
IP Litigation Statistics
                           The number of patent infringement suits filed is growing more than
                           3 times faster than the number of non-patent civil suits.
      Number of Patent
        Cases Filed        Cases don‟t settle as easily: of the 11,000 patent cases filed in the
                           last 5 years, more than half failed to settle in the first 12 months
                           and not before each side spent at least $1M in litigation costs.

                           Cases don‟t settle as often: 76% of patent cases settle prior to trial
                           versus 95% of all cases filed.

                           By time of resolution, the patent suits filed in 2000 will generate
                           roughly $4.2 billion in legal fees.

                           The Federal Circuit‟s reversal rate is nearly 50%.

                           When litigated, patents are found invalid or unenforceable 45% of
                           the time.

                           It‟s not just US companies that bring patent law suits: Amazin
                           Raisins (Canadian Company) sued Ocean Spray for patent
                           infringement last year in the US; Wi-Lan sued Cisco last year in

Patent Litigation by Industry

Patent Litigation Costs

     • Filing of statement of claim through trial = 1-3 years
     • Costs depend on complexity:
        – $50,000-$100,000 for simple patent case
        – $250,000-$400,000 for average patent case
        – $1,000,000 or more for complex patent case

     • Length of time to trial = 18 months-4 years
     • Costs depend on complexity and amount in controversy:
        – $2 million for case involving up to $25 million at risk (median cost)
        – $4 million for case involving over $25 million at risk (median cost)

IP Risk from the Risk Management Perspective

     Identify: What is the strategic business (financial) risk?

     Assess and Quantify: Is it material?

     • How can the risk be minimized or mitigated?
     • Is the risk appropriate for risk transfer?

     Why IP Risk Management?

      IP is brought “out of the attic” and into the mainstream thinking of the
       • Connect the IP legal risk analysis to the business case
          – company-wide
          – one division
          – one product
          – one transaction
       • Focus the company on the IP value proposition across the enterprise
          – maximize value
          – minimize risk
       • Connect the board of directors and senior executives and officers to
         the IP decisions that have a material effect on the company’s business
          – distinguish the significant IP risks/issues from the insignificant
          – communicate IP risk issues in understandable terms
          – improve the quality of decisions relating to IP risk
     The Five IP Perils

                                               LITIGATION                 IMPACT
                                          LITIGATION COSTS
                                                 COSTS                      IMPACT
                                    1. ENFORCEMENT EXPENSES   2. LOSS OF POSITION/VALUE
     Business: IP Owner
     Legal: Plaintiff            1. ENFORCEMENT EXPENSES       2. LOSS OF POSITION/VALUE
Business: IP Owner
     Risk Management: 1 st Party
Legal: Plaintiff
Risk Management: 1 st Party

     Business: Alleged Infringer  3. COST OF DEFENSE          4. DAMAGES/INJUNCTION
     Legal: Defendant
Business:Management: 3 rd Party 3.COST OF DEFENSE
     Risk Alleged Infringer                                    4. DAMAGES/INJUNCTION
Legal: Defendant
Risk Management: 3 rd Party



 Assessing IP Risk:
 Shaping the Seven Pieces of the Puzzle

 IP Profile                                                   Profile
 -Developed,                     Comparison                 -Type of Business?
 acquired,                                                  -Business Goals?
 licensed                       -IP protection of key
                                market differentiators    -Business Model?

      Service Profile
-What is the client in   Market Profile                    B-to-B Relationships
the business of          -Market Share?

1. IP Inventory
                                                                   IP Profile
     Do you know what you have?                                    -Developed,
      • Patents, copyrights, trademarks, trade secrets             acquired,
      • Licensed IP
      • Acquired IP
      • Any “non-proprietary” open source code
      • Are invention disclosure policies and procedures formalized, documented and

     Are IP due diligence policies and procedures formalized, repeatable and
     implemented for M&A activity?

     Are you receiving the appropriate royalty payments?

     Do you have piracy/counterfeiting issues?

     Are you maintaining and enforcing what you have?

     Have you properly valued what you have?
2. Product/Technology Inventory

     What are you making, using, selling, offering to sell, or importing?

     Where is it being sold?

     How is it being sold?

                                               Service Profile

3. Overlay IP and Product/Technology Profiles

     Where are the gaps?

     Are key market differentiators protected?

     What forms of IP are being used to protect key inventions and creations that
     are being commercialized?


4. Corporate Profile

     What is your corporate structure and culture?

     What are your business objectives?                             Corporate Profile
     What are your key revenue producing areas?

     Are you acquiring, divesting, investing (IP due diligence policies and procedures)?

     Who are your key employees and independent contractors (HR policies and
     procedures re: invention disclosure, invention assignment, confidentiality)?

                                                           Corporate Profile

5. Market Profile

     What‟s your market share?

     What‟s your market position?

     Do your competitors hold IP?

     Has there been IP litigation in the market?

     Do your suppliers‟ competitors hold IP?                  Market Profile
     Are there outliers holding IP in your technology area?   -Market Share?
     Any open source issues?

6. Revenue

     • What’s driving revenue now?
     • What will drive revenue in the future?



7. Business-to-Business Relationships

     Which way do IP indemnifications run?

     How are IP ownership rights determined and defined?

     What IP due diligence is done on suppliers, licensors, strategic partners?


Options for Transferring IP Risk
      IP Coverage, especially patent coverage, is usually a specialty line, named peril coverage.

      The Betterley Report--Intellectual Property Insurance Market Survey 2004 can be purchased at
      The executive summary can be viewed on the web site. Note that some of the information is already out-of-date.

      IP insurance underwriting methodologies are still developing and IP insurance underwriters have suffered significant
      losses, mainly through severity as opposed to frequency.

      IP-Related Coverages
       •   Media: provides some IP coverage related to publishing, broadcasting, advertising, marketing and promotional
           activities, and packaging; generally no coverage for software copyright infringement or utility patent infringement
       •   Cyber Liability: limited to web site activity
       •   Professional services: tech E&O
       •   CGL advertising injury clause provides extremely limited to no coverage

      Generally no coverage for misappropriation of trade secrets

      Bottom Line =
       •   Companies should avoid reliance on CGL coverage.
       •   Coverage is difficult to obtain.
       •   Coverage is generally expensive.
       •   Companies need to be “risk transfer ready.”
       •   Companies should purchase the appropriate coverage and seek tailored coverage.

Patent Coverage in a Nutshell

      Availability of Coverage
       •   IPISC (MGA for Gotham Insurance0
            – For patent infringement coverage, will write only single products for up to $3 million in limits (with some
            – For patent enforcement coverage, will write only no-known enforcement policies for up to $3 million (with some
            – Provides “multi-peril” coverage for named perils such as business interruption costs due to patent infringement
               litigation and loss in IP value ($1 million per peril)
       •   There really isn’t a middle market ($5-$25 million in limits) for blanket patent infringement
       •   Swiss Re and AIG
            – May offer catastrophic patent infringement coverage above a $25 million retention
            – Must have other lines of coverage with Swiss Re
       •   Ambridge Partners and The Hartford Specialty may write deal-specific patent infringement
           coverage and may write “excess” patent enforcement coverage
       •   Kiln only offers first party patent coverage to insure the value of the patent asset and/or licensing
           stream; some first party coverage may also be available from Swiss Re
       •   AIG and The Hartford Specialty offer patent litigation buyout coverage
       •   May be some new capacity for patent infringement and enforcement coverage in the Lloyd’s
           insurance market
      Pricing = varies, but the premium is anywhere from 3%-10% rate on line ($30,000-$100,000 per $1
      million in coverage) and a due diligence fee is frequently required

      You may have better luck obtaining patent infringement coverage if you exclude US claims
Outline of Typical IP Infringement
Terms of Coverage

      Insuring Agreement
        •    Coverage
        •    Defense and Settlement
      Persons Insured
      Limit of Liability
      Extended Reporting Endorsement
      Other Insurance
      Notice of Claim or Circumstance that Might Lead to a Claim
      Assistance and Cooperation of the Insured
      Action against the Insurer
      Material Changes
      War Exclusion Clause
      Service of Suit

IP Coverage: What to Look for

     Who is covered: Depending on the nature of the transaction and the risk being
     covered, it may be important for the licensee, licensor, sublicensees,
     distributors, or customers to be insureds or additional insureds.

     What is covered:
      • Peril 1: What types of litigation costs are covered, i.e. assertion of IP rights,
        defense against declaratory judgment actions and standard counterclaims
        such as invalidity, reexamination or interference proceedings in the
        USPTO, arbitration, appeals? How is the IP to be enforced defined?
      • Peril 2: Is there a formula for how the lost licensing revenue will be
      • Perils 3 & 4: Is it for blanket coverage? Certain product lines? Only certain
        types of infringement? To stand behind an indemnification provision? Is it
        for both legal expenses and damages?

IP Coverage: What to Look for

     What is not covered (exclusions): Fraudulent, willful, dishonest, or criminal
     acts are generally excluded, as are damages resulting from such acts; trade
     secret coverage is often excluded because it is so difficult to quantify.

     Prior acts coverage: Several infringement policy forms do not cover prior
     acts. Note carefully how prior acts are defined because a broad prior acts
     exclusion can effectively gut coverage. Also, enforcement policies are
     sometimes limited to “no known infringement” coverage.

     Coverage territory: Depending on the nature of the transaction and on the IP
     involved, you may need coverage beyond the US or coverage other than US

     Claims made v. occurrence: Most IP policy forms are claims made.

IP Coverage: What To Look For

     Underwriting Process: Because it is a specialty line coverage and there is a
     fairly wide variety of policy forms, the underwriting process itself and what
     information is required varies. Insurers are much more cautious about
     writing IP coverage and therefore are tending to require more information
     and are requiring that potential insureds bear the cost of due diligence.
     Certain safeguards should be put into place to protect the information being

     Claims Process: Note carefully what “claim” is defined to include. Also,
     make sure the policy is clear about how coverage is “triggered”. For
     example, for enforcement policies, the insured‟s counsel may need to
     provide claim charts, and the insurer may require some type of evaluation of
     the claim. For defensive policies, the insurer may require an opinion of non-
     infringement. As with the underwriting process, certain safeguards should
     be put into place to protect the information being provided.

IP Coverage: What To Look For

     Selection of Counsel: In many cases, the insured selects counsel, although
     the selection may be limited to selection from an approved panel or to
     counsel meeting certain criteria, or selection may be subject to carrier

     Settlement Consent: In many cases, the carrier cannot settle without the
     insured‟s consent.

Available Coverages and Markets

Alternative Risk Financing:
Single-parent captive
     Licensed insurance company owned by a parent organization that manages retained
     liabilities for sub organizations. Can insure almost any risk.

     However, it is not a form of risk transfer. All claims roll up to the organizations‟
     balance sheets.

     Therefore serves as a funding mechanism. Collects and consolidates claims data.
     Imposes operational discipline.


                Sub         Sub          Sub             Sub       Sub            Sub

                                                                   “Unrelated” Third
                                                                    Party Business
Alternative Risk Financing:
Structured or Finite Insurance

What is it?                                  Why Use it?

     The insured funds a significant           You can cover exposures that are
     portion of the insurance-policy limit     difficult to insure or cost prohibitive.
     at inception and then pays
     premium over multiple years.              You can hedge volatility from large,
                                               unexpected, and uninsured losses.
     Can include meaningful risk
     transfer in a blended program. Key        You can potentially accelerate tax
     considerations are:                       deductions.

     •    Appropriate accounting               You can create a risk solution that
         treatment                             is different from products in the
     •   Cash-flow management

 Sample Blended Finite Program Design
                                                                   Minimize reliance on traditional Risk Transfer market
                                                                   Provides ability to access traditional Risk Transfer market at a
                                                                     significantly higher attachment point
                                                                   Increases ability to budget (and fund) for significant shock losses over a
                                                                     multi-year term, thereby increasing P&L stability and signaling to the
$TBD MM                                                              market the use of a product to mitigate volatility.
                                                                   Significant risk transfer blended in to the Finite program which increases
          Monoline Risk Transfer                                     potential for achieving current deductibility of premiums
                                                                   Flexibility of coverage - Ability to manuscript and potentially modify the
                                                                     program to insure additional under insured and/or difficult to insure
$150MM                                                               exposures
          Additional Blended Finite Limits                         Availability of much larger amount of insurance for regulatory agencies,
                                                                     rating agencies, business partners, capital markets, et al.
                                                                   Access traditional Risk Transfer market for 2nd and/or 3rd loss
 $100MM                                                              protection, if Blended Finite limits are exhausted, at much reduced cost


                                                           Y 3
                                                                   Increased period-to-period expense due to higher “premium” payments at

                                                    Y 2
                                                     ear              inception to fund the Finite Program (Note: this may be offset against
                                             Y 1

                                                                      potentially lower Risk Transfer cost)

                                                                   Minimal premium discounting based on current interest rate
          Blended Finite Reinsurance                                  environment.
                                                                   Need to maximize value of policy via loss payments
                                                                   Insured does not have access to premium and loses ability to manage
                                                                   Defense costs included in funded layer.
                                                                   Difficulties in obtaining aggregate drop down requirements by mono-line
$TBD MM                                                            Commitment fees/Breakup fee requirements.

             Each & Every or Agg. SIR

Business Issues/Scenarios
Presenting IP Risk
     1.   What if your company is renegotiating/renewing a contract with its best
          customer and the customer requires uncapped IP indemnification? (and what if
          the customer does not want to rely on your client‟s balance sheet and requires
          some type of security behind the indemnification?)

     2.   What if your company wants to use the licensing stream generated from your IP
          as collateral for needed capital?

     3.   What if your company is about to initiate a patent enforcement effort?

     4.   What if your company is trying to determine whether and how to sell a new
          product that others are already selling?

     5.   What if your company‟s outside auditors have told you that they are not
          comfortable with how the company is setting reserves for potential and known
          IP exposures?
     6.   What if your company is re-negotiating a license agreement and needs help
          identifying leverage points and understanding the monetary value of discrete
          licensing provisions?
IP Risk Management of Business Issues–
Options and Opportunities

1.   Options re: indemnification:
      –    Narrow the scope of the indemnification
      –    Identify, assess, and quantify the risk and determine whether it would be material
      –    Conduct heightened due diligence on the customer
      –    Determine whether insurance is an affordable option and, if not, determine other
           ways to manage, finance, or transfer the risk
      –    Determine whether the company has similarly situated customers that may also
           require uncapped indemnification and whether an indemnification or warranty
           program makes sense

IP Risk Management of Business Issues–
Options and Opportunities

2.   Options re: insuring value/collateralization of IP
      –    Ensure that the company is in compliance with FASB 142 and Sarbanes Oxley
      –    If loss of the IP could be material, then determine whether first party insurance
           coverage is appropriate (Kiln 4Thought product, Swiss Re product, IPISC multi-
           peril coverage)
      –    If your company needs capital now, then the company may be able to
           collateralize its IP and/or existing licensing revenue stream (may require first
           party IP coverage to secure the collateral)

IP Risk Management of Business Issues–
Options and Opportunities
3.   Options re: patent enforcement effort
      –    Contracts: be clear about who bears of the costs of enforcing
      –    Assessment: weigh the cost and risk factors associated with an enforcement
      –    Funding: build a “war chest” (i.e. by going after smaller infringers first, by building
           costs into the litigation department’s budget over time), arrange for contingency
           or partial contingency fee with counsel, sell the IP with remainder interest in a
           percentage of licensing revenue from an enforcement program instituted by the
           buyer, negotiate some other type of investment arrangement, purchase
           enforcement insurance (limited availability)
      –    Selection of counsel: track records count, agree up front on reporting and billing
      –    Litigation plans and budgets: should be required for each case, should be
           structured on a quarterly basis, should be tracked

IP Risk Management of Business Issues–
Options and Opportunities
4.   Options re: new product
      –     Before your company invests R&D and product development dollars or invests in
            a product clearance opinion, do your homework
          •     Who is in the market already?
          •     Who owns what IP on the technology incorporated into the product?
          •     Who is licensing from whom?
          •     Who is making money on the product?
          •     Where is the product being sold?
          •     Who are the inventors on the key patents and where are they?
          •     What are the key differentiators of the products in the market? Are the key
                differentiators protected by IP?

IP Risk Management of Business Issues–
Options and Opportunities

     5.   Options re: reserve setting
           –     Does your company have a consistent, uniform and documented process
                 for setting reserves for both known and potential exposures?
           –     At what point is an exposure “material” to your company’s balance sheet?
           –     What financial vehicle does your company have in place to address
                 known and potential exposures?
           –     Is your company faced with a remote but potentially catastrophic risk
                 where a financial vehicle is needed to smooth the volatility of the risk?
           –     Options:
               •      Disciplined budgeting process for risk management and legal and
                      other relevant departments
               •      Self-insurance vehicles such as captives that meet FASB section 113
               •      Combination of self-insurance and commercial insurance (finite risk
               •      Commercial insurance

IP Risk Management of Business Issues–
Options and Opportunities

6.   Options re: license negotiations
      Make sure due diligence includes financial information
      Do you know the market?
      Have you identified all potential licensees?
      Have you researched comparable royalty rates?
      Do you know the monetary value of discrete license provisions?
      What are the financial pros and cons of expanding/narrowing the field of

Thank you!



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