Expert Commentary

Intellectual Property Coverage: Are You Naked?

The cost of intellectual property litigation can be astronomical, and continues to increase each year. In certain cases, the high stakes of intellectual property litigation can pose a very real threat to the company itself. Learn about the exposure and how to properly cover yourself.


Intellectual Property
May 2001

Get your mind out of the gutter. I'm not concerned with what clothes you may or may not be wearing right now. If you want to run around in your birthday suit, feel free—just please stay out of my office while you're doing it. (Unless, of course, you're coming in to bring me a few million dollars' worth of business, in which case you can pretty much run around wherever the heck you want, as far as I'm concerned.)

Running around in your skivvies may get you arrested, castigated, or even committed, but even in the worst case, you'll probably survive. You may get probation, but there's no death penalty for public nudity. Unfortunately, what's true for people isn't true for technology companies. In the world of intellectual property, getting caught naked in the technology business can very well carry a very painful death penalty for your company.

This article deals with developing a plan of action for dealing with intellectual property litigation issues that are becoming more and more common in the modern high-tech business world. In particular, I want to direct your attention to the ever-increasing likelihood that a company will be involved in intellectual property litigation, the costs and headaches such litigation can—and generally does—give rise to, and some strategies for dealing with litigation before it deals with you. There's no question that you need to prepare your business for effective competition in the cutthroat, rough-and-tumble world of the modern intellectual property business, in which competition often takes place in the courtroom as much as in the marketplace. Given current trends, this is becoming truer every day.

In a perfect world, good guys would always win, bad guys would always lose, and lawsuits would be cost-free, hassle-free expeditious affairs that settle disputes between honest, above-board competitors seeking merely to determine the just and rightful winner of the issue. In the real world, good guys often lose, bad guys often win, and lawsuits are often expensive, grueling, protracted grudge matches between cutthroat competitors seeking to gain any advantage over their competitors. In the real world, even the winner of a protracted, expensive intellectual property trench war may sustain so much damage in the course of the litigation, financial and otherwise, that the very survival of the company is placed in jeopardy.

A Million Paper Landmines

Patent litigation is the prime example of the growing likelihood and expense of intellectual property litigation. Between 1996 and 1999, the number of patent applications filed annually grew from just over 200,000 per year in 1996 to over 300,000 per year in 1999. In 1998 the U.S. Patent and Trademark Office granted a record 163,209 patents, an increase of 31.5 percent over the 124,126 patents issued in 1997.

The number of patents granted has continued to increase each subsequent year, to the point that number of issued U. S. patents recently exceeded 6.2 million. Over a million of the issued patents remain in force today. Each and every patent issued represents a "paper landmine" under the control of the patent holder.

As would be expected, statistics show that patent holders are by no means shy about taking advantage of the competitive advantage afforded by their patents, and the court battles continue to heat up. Between 1982 and 1994, the number of patent infringement suits approximately doubled, growing from 843 in 1982 to 1,535 in 1994, at an average rate of just over 5 percent per year. Between 1996 and 1999, the number of patent infringement suits increased from just over 1,600 to over 2,300, growing at an average rate of over 10 percent per year.

Statistics have shown that the chance that any randomly selected patent will be involved in litigation during its effective lifespan is a little over 1 percent. Studies have shown, however, that certain patents have a much higher-than-average chance of being involved in litigation during their lives. Certain classes of pharmaceutical patents, for example, have a greater than 25 percent chance of being involved in litigation, while patents covering other key technologies have a better than 10 percent chance. This is completely understandable owing to the fact that, while most patents cover small advances over known technology, certain patents represent pioneering advances in valuable technology. These pioneering advances represent serious money, and the big players are ready, willing, and able to wage massive and expensive legal battles over that technology.

Certain competitors take an aggressive stance with respect to issued patents in their technology, designing as close as possible to the literal scope of the issued patent claims. Such competitors are virtually guaranteeing a conflict with all but the most open-minded and gun-shy patent holders. Even the litigation-wary who steer well clear of all issued patents in their technology areas can, however, find themselves hit with a patent of which they could under no circumstances be aware.

Under Patent Office regulations, patent applications have, under most circumstances, been kept secret by the Patent and Trademark Office prior to issuance. Therefore, it is completely possible for a company to develop its product lines diligently and in good faith in such a way that none of their products infringe any patent on day one, and yet infringe a patent that issues on day two. Owing to the particulars of the patent system, the infringer may have no advance notice of its own infringement, despite its best efforts. On the day of issuance, the unwary company could be hit with a patent infringement lawsuit without any advance notice of the liability. Recent changes in Patent Office procedure providing for less secrecy will make this less likely in the future, but the possibility remains of being caught in a lawsuit completely unaware of one's own infringement.

The chance that a high-tech business will be involved in an intellectual property infringement suit continues to rise, and so do the stakes. The legal fees incurred in the defense of a patent infringement lawsuit averaged $1.5 million in 1999, up by over $500,000 since 1995, and copyright infringement defense is known to cost upwards of $150,000.

Although attorney's fees are available to the successful defendant in certain cases, such awards are certainly the exception rather than the rule. Even in the best-case scenario, where all attorney's fees are awarded to the defendant, such relief may very well be "too little, too late." Any such relief will generally be granted, if at all, years after the initiation of the litigation. In the intervening years, the defendant is faced with the task of coming up with the cash to keep the war machine running, while at the same time attempting to run a business.

If you think it's expensive to fight, you don't even want to know how much it can cost to lose. Intellectual property awards have only continued to climb in recent years, with patent infringement awards leading the charge. A few of the larger intellectual property infringement awards and settlements of recent years include the following:


Honeywell v Litton $1.2 billion
Polaroid v Kodak $900 million
DCS Communications v General Instruments $140 million
Fonar v General Electric $128 million
Honeywell v Minolta $128 million
Stac Electronics v Microsoft $120 million

On the other hand, not all the big awards are from patent disputes. Witness Trovan, Ltd., which was awarded $143 million in a trademark case against Pfizer, Inc. The point is made: IP litigation is definitely not for the faint-of-heart or the light-of-pocket.

The huge damages often awarded in patent infringement actions result from a number of factors, but the principal factor relates to the laundry list of damages available for patent infringement, which include lost profits, reasonable royalties, punitive enhancement, interest assessments, and attorney fees. A reasonable royalty is considered the minimum floor for calculation of damages. In most cases, an award of a reasonable royalty by itself would probably not bankrupt the defendant. Lost profits, on the other hand, very well could bankrupt a defendant, particularly where a large patent holder has sued a small infringer. In certain cases, the court may award both reasonable royalties and lost profits. In exceptional cases, the successful plaintiff may be entitled to enhanced damages of up to triple the calculated amount, in addition to costs and attorney's fees. It is not hard to see how the numbers can quickly add up.

Even if the damages awarded are low, the accused defendant faces the very real possibility of an injunction foreclosing some or all of its business activity in the patented technology. A sufficiently broad injunction can kill a business even faster than a heavy monetary loss.

With these harsh realities, it is no surprise that many defendants find themselves negotiating from a position of weakness against a larger and better-capitalized plaintiff, considering that damages can range between a "best case" of low seven figures to a "worst case" of $1.2 billion. Although it may be difficult to verify, it wouldn't be surprising to find that many small defendants settle lawsuits that they'd have very little chance of ultimately losing, owing simply to the financial realities of intellectual property litigation. Whether you would ultimately win or ultimately lose is of no consequence if you can't afford to fight.

Although the small plaintiff is in a somewhat better position than the small defendant, many of the same factors apply. A small company holding a valid patent may have every reasonable expectation of a successful ultimate outcome in a patent infringement suit against a larger, better-capitalized defendant, and yet not proceed. Even if the small company does proceed, it may settle the lawsuit on much inferior terms as compared to those that might be otherwise negotiated.

Intellectual Property Coverage under the CGL

Clearly, the risks surrounding intellectual property litigation are high. Traditionally, intellectual property litigation has been viewed as a risk inherent to technology-related business. Although companies routinely look to their insurers for assistance with risk management and with claims giving rise to expensive litigation, the idea of insurance protection for intellectual property claims is a relatively new concept. Many business owners may be surprised to find out that, in addition to physical injury claims protection, the standard commercial general liability (CGL) insurance policy provides coverage for certain claims arising from intellectual property-related "advertising injury," which is defined as injury arising out of "advertising activities." This is particularly true for claims related to copyright, and to a lesser degree, trademark infringement.

Most companies are engaged in a broad range of activities that could not reasonably be considered "advertising activities." Under the standard CGL policy, intellectual property infringement claims arising out of these activities would not generally be considered covered by the policy. Additionally, acts of infringement that can be considered intentional are likely to be denied by the insurer. For defense of these types of claims, the accused infringer is on its own under the terms of the standard CGL policy.

Intellectual Property Insurance Coverage

In order to prepare for the very real possibility of intellectual property litigation not covered by the standard CGL insurance policy, many companies have taken out specialized insurance coverage to protect against claims falling outside of the scope of "advertising injuries." These types of policies are becoming increasingly popular. According to one survey, intellectual property insurance coverage has been growing at a rate of 300 percent annually in recent years. The most popular form of intellectual property insurance coverage is "defense" coverage, which covers the costs of defense of an intellectual property infringement suit and any resulting settlements or judgments.

In addition to "defense" coverage, companies holding a valuable intellectual property portfolio sometimes purchase "enforcement" or "pursuit" coverage, which is designed to aid the policyholder in pursuing infringers. This may be particularly valuable to a small company that is concerned that its valuable patent rights may be infringed by a larger and better-capitalized competitor. Absent such insurance, the larger competitor may be more likely to infringe the smaller company's intellectual property rights with the expectation that the small company may not be able to afford to defend its rights.

This sort of coverage may be particularly valuable to a small technology company having an asset base consisting largely or entirely of a small portfolio of intellectual property. Faced with a shameless infringer, the small company has the option of either allowing the competitor to infringe, thereby jeopardizing its only assets, or filing suit on its own dime, thereby jeopardizing its financial stability. Enforcement insurance provides the small technology company with a way to protect its rights and its financial stability.

Conclusion

The cost of intellectual property litigation can be astronomical, and continues to increase. In certain cases, the high stakes of intellectual property litigation can pose a very real threat to the company itself. Furthermore, the risk that a given company will be involved in some form of intellectual property litigation continues to increase. Given these facts, it is understandable that certain insurers have developed policies tailored to the needs of the technology company concerned about these risks. In general, the range of protection available under any of the various policies available can often be tailored to meet the needs of the policyholder.

Intellectual property insurance coverage may not make sense for every company. For the small technology company having an intellectual property portfolio as its most valuable asset, or for the new competitor trying to break into a market in which aggressively enforced intellectual property rights are the rule rather than the exception, the right level of insurance protection may mean the difference between survival and mortality. In other words: Don't run around naked!


Ken Emanuelson is an associate with the intellectual property section of Gardere & Wynne, LLP. His clients range in size from small startups to established Fortune 500 companies, in various areas of technology, from online commerce to aerospace. His regular practice includes client counseling in all areas of intellectual property law, patent and trademark drafting and prosecution, litigation, licensing negotiation, and infringement analysis. In his prior career as an engineer, Mr. Emanuelson worked for Texas Instruments and Ford Motor Company. His engineering experience included work in semiconductor processing, factory automation, microwave communications, aerospace materials, automotive technology, and superconductive ceramics. Mr. Emanuelson is a graduate of the University of Texas School of Law, where his course of study focused primarily on patent, trademark, and copyright law. He also holds a BS degree in mechanical engineering from the University of Arkansas. He can be reached by email at


Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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