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Advancing and
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Volume XLIX No. 1
Development,
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LES NOUVELLES
Advancing and Enhancing Business
Development, Deals & Innovation
les Nouvelles
March 2014
Advancing the Business of Intellectual Property Globally
The Nash Bargaining Solution
DOUG KIDDER AND VINCE O’BRIEN — Page 1
Survey Results Confirm Growing Trend In Favor Of ADR
JUDITH SCHALLNAU, COMMENTS BY RUSSELL LEVINE — Page 6
Patent Technology Landscapes For Assessing Intellectual Property
In Academic Environments
JOE WYSE, KEN ZINDA, GREG GERHARDT, BOB GREGORY AND ERIC A. GRULKE — Page 15
Venture Capital 101: Financing Mentality,
Jargon, Term Sheets, and Documents
LOUIS P. BERNEMAN AND CHRISTOPHER F. WRIGHT — Page 25
The Exhaustion Theory Is Not Yet Exhausted: Part 3
ERIK VERBRAEKEN — Page 37
Maximizing The Value Of License Agreements
LOUIS P. BERNEMAN, TODD C. DAVIS, D. PATRICK O’REILLEY AND MATTHEW RAYMOND — Page 45
What’s Happening With Semiconductor IP Deals?
DAVID R. JARCZYK — Page 50
Valuation Discussion Factors In Early Stage Software
DWIGHT OLSON — Page 53
Biomedical Patent Securitization in Taiwan
MEI-HSIN WANG — 59
OCTOBER 5–8, 2014 | SAN FRANCISCO
Recent U.S. Court Decisions And Developments Affecting Licensing
JOHN PAUL AND BRIAN KACEDON — Page 72
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Nash Bargaining Solution
By Doug Kidder and Vince O’Brien
Summary
In patent litigation, the ruling against the 25% Rule has
led some plaintiff’s experts to search for a methodology
to replace it. Some of these experts are putting forward
claims based on a 50/50 split of profits by claiming that it
is the result of the Nash Bargaining Solution. This is not
only a misreading of Nash’s work; the economic community has not accepted that Nash Bargaining is a good
predictor of outcomes in the real world. The 50/50 split
posited by Nash requires a set of assumptions that are
not true in actual negotiations. One valuable insight in
Nash Bargaining is that the parties are negotiating over
a surplus that is equal to the benefits achievable from
cooperating minus the sum of the payoffs each side is
able to get without cooperating.
1. Introduction
S
ome patent damages experts are putting forward estimates that they claim are based on the
Nobel Prize-winning work of John Nash.1 In their
telling, the Nash Bargaining Solution (NBS) applied
to the hypothetical negotiation leads to a royalty
rate of 50 percent on the profits of the patented
product. However, this is neither an actual application of the NBS nor is it supported by the outcome
of actual negotiations.
2. The applications we’ve seen of the NBS (all in the
context of patent litigation) are uniformly distortions
of Nash’s work. The NBS posits that, under idealized
conditions when two parties can benefit by cooperation, they will split the surplus equally; i.e. “50/50.”
While plaintiff’s experts have seized on the 50/50
split, they haven’t been as quick to grasp what is to
be split—and it’s not the entirety of the profits from
the patented product. Under Nash Bargaining the
surplus to be split is not the total benefit from the sale
of the patented product, it is the total benefit from
the patented product minus the total benefit each
side could receive if it chose not to enter the license
(“cooperate”), but pursued a different course of action. For example, if I’m contemplating manufacturing
a patented product that will earn me $10 and I have
an unpatented product that I could manufacture that
1. In particular, see: Weinstein, R., Romig, K., Stabile, F., “Taming Complex Intellectual Property Compensation Problems,” TTI
Vanguard Conference “Taming Complexity,” October 4-5, 2011.
will earn me $9, then the amount to split is not $10,
it is no more than $1. This understanding is crucial to
applying the NBS. However, in the applications we’ve
seen to date, damages experts have applied a 50/50
split to some level of profits from the accused product without subtracting anything for the infringer’s
alternative courses of action. This is methodologically
indistinguishable from the 25% Rule, which the CAFC
ruled is not an acceptable methodology for calculating
a reasonable royalty.2
■ Doug Kidder,
3. Even when the benOSKR,
LLC,
efit is properly defined,
Director,
the NBS doesn’t work for
patent damages because
Emeryville, CA, USA
NBS relies on assumpE-mail: [email protected]
tions that are demonstra■ Vince O’Brien,
bly false in the real world.
OSKR, LLC,
The NBS and other soluDirector,
tions based on the notion
Emeryville, CA, USA
that humans were enE-mail: [email protected]
tirely rational economic
beings have been tested
and found wanting. In
fact, two economists were awarded the Noble Prize
in Economics for developing the field of Behavioral
Economics which challenged these rational solutions.3
In particular, the assumptions underlying the NBS do
not hold for the Hypothetical Negotiation described
in Georgia Pacific.4
2. What Is Nash Bargaining?
4. John Nash was attempting to devise a solution
to a question that had been puzzling economists for
decades: how do economic surpluses get divided up
in the real world? Prior to Nash, the answer to this
question was indeterminate. There was no economic
theory that determined how much of the surplus each
party to a negotiation would receive. If two parties
were negotiating over $10, each side might receive
2. Uniloc USA v. Microsoft, US CAFC 2010-1035, -105, January 4, 2011. For a more detailed discussion of the multitude of
problems with the 25% Rule, see Kidder, D., O’Brien, V., “Simply
Wrong: The 25% Rule Examined,” les Nouvelles Journal of the
Licensing Executives Society, December, 2011.
3. For example: Daniel Kahneman and Vernon Smith in 2002.
4. Georgia-Pacific Corp., v. United States Plywood Corp., 318 F.
Supp. 1116 S.D.N.Y. (1970); aff’d, 446 F.2d 225 (1971).
March 2014
1
any amount from $0 to $10. This is still true in the
real world.
5. What Nash did was to show that, if both parties
to the negotiation were perfectly rational with identical and linear preferences and perfect knowledge
of each other, then—and only then—the surplus
would be split equally. While much of the focus on
Nash is on the equality of the split, in our opinion,
the critical observation is the amount to be split. In
the next sections we discuss how NBS works and
then examine some of the assumptions it requires.
2.1 How NBS Works
6. The surplus to be divided under Nash Bargaining
is not simply the benefit from cooperating (entering
an agreement): it is the benefit from cooperating
minus the sum of the “disagreement payoffs” of the
parties. Disagreement payoffs are also called “reservation prices” or “threat points.” The reservation
price of a party is the amount that can be received
by that party from pursuing a course of action other
than cooperating.5
7. To illustrate the surplus to be divided by NBS,
we will use a hypothetical example involving a
manufacturer negotiating for an exclusive license
from a patent owner. For our example assume that
the benefit from manufacturing the patented good
amounts to $10 per unit and that the manufacturer
could obtain a benefit of $8 per unit from manufacturing an alternative product.6 Further, assume that
the patent-owner had an offer to exclusively license
the patent to a different manufacturer for $1 per
unit.7 Thus, the disagreement payoffs are $8 for
the manufacturer and $1 for the patent-owner. The
manufacturer would not agree to any license that gave
it less than $8 profit per unit and the patent-holder
would not agree to any license that gave it less than
$1 per unit. Under NBS the surplus to be divided is
the remaining $1; the $10 in benefits minus the $8
reservation price of the manufacturer minus the $1
reservation price of the patent-owner. In this way,
the manufacturer and the patent-owner are negotiating over the amount that they can only receive by
5. The use of terms “benefit” and “payoff” as opposed to “profit”
or “incremental profit” is intentional. The latter are accounting
concepts that do not take into account the alternatives nor include
a charge for the use of capital. These are important in determining
the surplus that the parties would be willing to divide.
6. For the purposes of this example, assume that the quantities that would be manufactured and sold of the patented and
unpatented items are identical.
7. Assume that the alternative licensor would produce a volume
equal to the hypothetical manufacturer.
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les Nouvelles
cooperating. Nash then proposes that this $1 surplus
will be split equally. For this example Nash Bargaining
predicts that the manufacturer would get $8.50 per
unit ($8 reservation price plus half of the $1 surplus)
and the patent-holder would receive $1.50 per unit.
8. The outcome of the Nash Bargaining solution is
very sensitive to the quantification of the reservation
prices. Notice what happens if the manufacturer has
an alternative product—one that is perhaps completely unrelated to the patented product—that can
be produced for a benefit of $9 per unit if it isn’t
producing the patented product. Then the sum of
the reservation prices would equal $10 and there
is no surplus to be divided and hence no point to
concluding a negotiation.
9. Thus, Nash Bargaining requires an analysis of
each party’s next best alternative assuming it doesn’t
enter the agreement. This goes significantly beyond
the “invent around” discussion in patent cases and
includes strategic as well as marketing alternatives.
A completely unrelated product—not simply the
allegedly-infringing product without the patented
technology—can provide a reservation price. Without
an examination of the parties’ next-best alternatives,
the analysis is not specific to the patent or the parties.
In particular, applying a 50/50 split to any standard
accounting profits without deducting the manufacturer’s disagreement payoff will substantially overvalue the patented technology in the NBS framework.
2.2 Assumptions Critical To NBS
10. As Dr. Nash put it:
In general terms, we idealize the bargaining
problem by assuming that the two individuals are
highly rational, that each can accurately compare
his desires for various things, that they are equal in
bargaining skill, and that each has full knowledge
of the tastes and preferences of the other.8
11. Nash’s theory also relies on some additional
assumptions:
• The parties tastes and preferences, i.e. their
utility functions, are linear; and
• The outcome of the negotiation is independent
of irrelevant alternatives.9
12. Nash also implicitly assumes that the negotiation is completely isolated from any other negotiation
or strategic consideration. For example, in the NBS,
8. Nash, J., “The Bargaining Problem,” Econometrica, Vol. 18,
No. 2 (Apr. 1950), pp. 155-162.
9. We explain this rather abstract term later in the paper.
there is no consideration of any relationship beyond
the negotiation (e.g. whether the parties to the negotiation are competitors or inventor/promoter.) There
is also no consideration of the results of previous
negotiations or of any established licensing program.
Under NBS each deal is unique and uninformed by
past deals or the prospect of future deals. In the world
of Nash Bargaining, a license for the same patent to
100 different companies would naturally yield 100
different royalty rates. This is methodologically opposite to a Georgia-Pacific analysis, which is grounded
in an analysis of prior licenses.
13. A very important aspect of the NBS is that all of
its assumptions and conditions are absolutely necessary to arrive at the conclusion of an equal division
of the surplus. If any one of these assumptions is not
true in any particular negotiation, then the outcome is
indeterminate. In particular, one cannot use a GeorgiaPacific analysis to “adjust” the 50/50 split as that is
an admission that one or more of the assumptions
and conditions required to apply the NBS are invalid.
14. In general, Nash’s theory relies on assumptions
about human behavior that seem plausible, but are
not valid. Specifically, people are assumed to be rational and utility maximizers. However, the growing
evidence from behavioral economics indicates that
people aren’t as rational as required by NBS. As stated
by the Nobel Laureate Daniel Kahneman writing with
Amos Tversky:
We first sketch an analysis of the foundations of
the theory of rational choice and then show that
the most basic rules of the theory are commonly
violated by decision makers. 10
15. One particular and explicit assumption underlying NBS that has been widely shown to be violated
in the real world is the “Independence of Irrelevant
Alternatives” or “IIA.” The IIA assumes that the existence of a third choice that is worse than the first two
choices will not affect the final decision. The IIA is
illustrated by the following: if I am choosing between
a peach and a pear and I prefer peaches, then I will
choose the peach. And if I am choosing between a
peach, a pear and an apple, then I will also choose the
peach if I prefer pears to apples. My preferences are
ranked peaches > pears > apples so the addition of
an apple into my choice set is irrelevant to my selection. I will still choose the peach.
10. Tversky, A., Kahneman, D., “Rational Choice and the
Framing of Decisions,” The Journal of Business, Vol. 59, No. 4,
Part 2: The Behavioral Foundations of Economic Theory. (Oct.,
1986), pp. S251-S278.
16. However much appeal the IIA has as a theoretical construct, it isn’t actually true in the real world.
People’s choices are affected by irrelevant alternatives. There are multiple experiments demonstrating
this. As described in a paper by Amos Tversky and
Itamar Simonson:
One group (n = 106) was offered a choice between $6 and an elegant Cross pen. The pen was
selected by 36 percent of the subjects and the
remaining 64 percent chose the cash. A second
group (n = 115) was given a choice among three
options: $6 in cash, the same Cross pen, and a
second less attractive pen. The second pen, we
suggest, is dominated by the first pen but not by
the cash. Indeed, only 2 percent of the subjects
chose the less attractive pen, but its presence
increased the percentage of subjects who chose
the Cross pen from 36 percent to 46 percent...11
17. In this experiment, the addition of a lowquality pen to the choice between money and a
high-quality pen—a third, supposedly irrelevant
option—increased the percentage of people who
chose the nice pen over the cash. In other words,
approximately 10 percent of the people reversed
their preference for cash over the nice pen because
they were offered another option that was clearly
inferior to the nice pen. This 10 percent originally
ranked nice pen > cash, but when presented with
an inferior pen they ranked cash > nice pen. The
IIA states that the low-quality pen is the irrelevant
option and thus should not affect the decisions of
the players; but it does.
18. The IIA assumption matters greatly to the Nash
Bargaining Solution. Without a neat ordering of preferences, utility functions become not just non-linear,
but essentially unmanageable. Much as we’d like to
be able to simplify actual utility functions, they are
not the neat, linear constructs needed to arrive at a
50/50 split of the profits from agreement.
19. The NBS also requires that each side know with
certainty the other sides’ disagreement payoffs and
that both sides have identical utility functions. These
assumptions are clearly not true in real negotiations.
The NBS 50/50 split is elegant, but it requires a set
of idealizations that render it useless for predicting
the outcome of a real negotiation.
20. As one game theorist wrote:
… I have never heard an economist seriously
11. Tversky, A., Simonson, I., “Context-Dependent Preferences,” Management Science, Vol. 39, No. 10, pp. 1179-1189.
March 2014
3
claim that the Nash bargaining solution is a good
predictor of bargaining in real markets…12
21. The economic community has never accepted
the NBS as an accurate predictor of actual outcomes.
As such, it clearly fails the Daubert requirement that
it be an established methodology.
3. The NBS Can’t Be Used With
Georgia-Pacific
22. The Georgia-Pacific Factors can’t be combined
with the NBS because they are methodologically
opposed. The hypothetical negotiation described in
Georgia Pacific is designed to replicate a real world
negotiation and its outcome. In contrast, the NBS
is described by Nash as an “idealized” bargaining
situation.
23. In the hypothetical negotiation, the parties do
not know each other’s “tastes and preferences” or
“utility functions.” Moreover, their utility functions
are certainly not linear or identical.
24. The hypothetical license is usually for a multiple
years and, by implication from Georgia Pacific Factor
7, for the life of the patent. The NBS does even not
address the long term consequences of cooperation
between the parties. The negotiation is assumed to
take place and benefits obtained instantaneously.
25. The hypothetical negotiation described in
Georgia-Pacific incorporates past licensing history
in Factors 1, 2 and 12, and strategic considerations
in Factors 4, 5, and 6. The NBS does not. All of the
broader implications of the bargain are not considered
by the NBS.
26. The NBS also requires certainty and symmetry
between the parties—and without that certainty the
split of any surplus is indeterminate. Under NBS,
there is no room for the calculation of the surplus to
be uncertain—as it is in the real world. In the real
world, not only are the benefits of the bargain uncertain (How many units will be sold? What price will
be acceptable to consumers? How will competitors
respond? What will manufacturing costs be in two
years? Etc.) but the disagreement payoffs are also
uncertain. Thus, there is considerable uncertainty
about the surplus and consequently significant risk
in the outcome. The NBS does not address this.
27. Uncertainty about the surplus is a defining
characteristic of the hypothetical negotiation. The
Hypothetical Negotiation is required to be set at the
12. Rubinstein, A., “John Nash: The Master of Economic
Modeling,” Scand. J. o/Economics, 97(1), 9-13,1995.
4
les Nouvelles
date infringement begins. This is a date before the
benefits of cooperation are known. An appeal to the
Book of Wisdom to incorporate future knowledge into
the date of the hypothetical reduces the uncertainty
about the benefits from the patented product, but it
does not reduce the uncertainty about the amount
of the disagreement payoffs.
28. The NBS does not consider the relative risks
of the parties. Under NBS, there is no way for either
party to lose money from cooperating, yet, in the real
world, that is a possible outcome. A manufacturer
could pay more to access a patented technology than
he will obtain in benefits from selling that patented
technology.13 Thus, one consideration in the Hypothetical Negotiation is the assumption of risk. Under a
running royalty license: the risk of sales volume being
higher or lower than expected is shared, the risk of
profitability is entirely absorbed by the manufacturer,
and the risk that the manufacturer will stop using
the patented technology is entirely absorbed by the
licensor. In a lump sum license, all risk is absorbed
by the manufacturer—in exchange for a discount to
the present value of an expected running royalty.
Under Nash Bargaining, there is no consideration of
these tradeoffs for risk and division of any surplus.
29. Nonetheless, we do believe that the NBS does
contribute to patent damages calculations. While
the 50/50 split rests on idealized assumptions that
are not valid in the real world, the definition of the
surplus under the NBS is useful when considering
patent damages. The calculation of the surplus takes
into account each party’s alternatives, reservation
prices and costs of capital. However, using the 50/50
split posited by NBS as a check or supplement to a
Georgia-Pacific is wrong as it is an admission that the
NBS assumptions and conditions are violated.
4. Discussion Of Cases
30. The NBS has been met with mixed success in
the courts. When it was used as the sole basis for the
royalty rate, it has been rejected. When used as “a
check” on or supplement to a Georgia-Pacific analysis, it has met with some acceptance. A discussion
of these cases is below with the most recent first.
31. Suffolk Tech. LLC v. AOL Inc. and Google Inc.,
Case No. 1:12-cv-625 (Doc. No. 518), Eastern District
of Virginia, Judge Ellis, April 12, 2013. NBS rejected
as being no different than the 25% Rule.
13. This is even before a consideration of alternative products
that could have been produced that would have yielded greater
total benefits.
32. VirnetX Inc. v. Cisco Systems, Inc., Case No.
6:10-cv-00417-LED (Doc. No. 745), Eastern District
of Texas, Tyler Division; March 1, 2013; Judge Leonard Davis. NBS allowed. NBS accepted as “… the
traditional 50 percent—50 percent profit split” and
applied to “gross profit.” While we don’t know the
specific details that led to a 50/50 split being characterized as being “traditional,” the court appears to
have gotten this wrong. NBS is not traditional and
does not involve splitting gross profit.
33. VirnetX Inc. v, Apple Inc., Case No. 6:10-cv417) E.D. of Texas, Tyler Division; February 26, 2013;
Judge Leonard Davis. NBS allowed although most of
the dispute was over whether the expert had correctly
measured the profits due to the infringed technology.
34. Gen-Probe Inc. v. Becton Dickinson & Co.,
Case No. 09-CV-2319 BEN NLS and 10-CV-0602
BEN NLS, Southern District of California, November
26, 2012. NBS allowed in addition to the expert’s
real world observations.
35. Mformation Techs., Inc. v. RIM, No. C 08-04990,
Northern District of California, Judge Ware, March 29,
2012. NBS allowed as a “check” on a reasonable royalty
derived through a Georgia-Pacific analysis.
36. Solvay, S.A. v Honeywell Specialty Materials LLC et al., 06-557-SLR, District of Delaware,
Judge Sue L. Robinson, September 8, 2011. NBS
allowed because the expert testified that a 50/50
split is also supported by her ”review of thousands
of agreements over 33 years of [her] career.” Interestingly, the expert challenged was retained by the
Defendant and the Plaintiff was challenging the use
of the NBS. Also, it’s hard to see how a review of
license agreements would reveal anything about the
parties’ split of profits. About all one can extract is
that the royalty rates or lump sum payments tend
to be small relative to sales. This would suggest that
either the incremental profit is small or that the split
favors the licensee.
37. Oracle America, Inc. v. Google Inc., No. C 1003561, Northern District of California, Judge Alsup,
July 22, 2011. NBS firmly rejected with comments
like:
“It is no wonder that a patent plaintiff would love
the Nash bargaining solution …”
“The Nash bargaining solution would invite a miscarriage of justice by clothing a fifty-percent assumption in an impenetrable facade of mathematics...” ■
March 2014
5
Survey Results In Favor Of ADR
Survey Results Confirm Growing Trend
In Favor Of ADR
By Judith Schallnau, comments by Russell Levine
F
or companies, research entities, universities and
others, intellectual property (IP) has become an
essential business asset as well as a means of
creating value. It is being developed and exploited on
an increasingly international level in various contractual relationships, such as research and development
contracts, consortium agreements, licenses, purchase
contracts, distributorships and joint ventures. With
the increase of such transactions, the number of IP
disputes increases. Disputes arising in relation to IP
assets as critical elements of economic value can cause
serious damage. The resources required to handle
such disputes can be considerable, especially if the
dispute involves litigation in multiple countries. At the
same time, such disputes place a serious burden on
the continuation and expansion of business. Careful
consideration of the risks associated with technologyrelated disputes goes a long way in preventing, and
resolving disputes. A strategy to manage such risks
and to resolve any potential disputes rapidly and costeffectively, therefore, is critically important.
To gain a better understanding of technology-related
dispute resolution strategies and practices, the WIPO
Arbitration and Mediation Center (WIPO Center)
recently conducted the international WIPO International Survey on Dispute Resolution in Technology
Transactions1 (Survey) to obtain statistical information
on the current use of alternative dispute resolution
(ADR) mechanisms, such as mediation and arbitration, as compared to court litigation when it comes
to resolving such disputes.
1. The results of the WIPO International Survey on Dispute
Resolution in Technology Transactions are available at: www.wipo.
int/amc/en/center/survey/results.html. The Survey was developed
with the support of an expert group comprising in-house counsel
and external experts in technology disputes from a broad range
of jurisdictions and business areas, various professional associations, including the International Association for the Protection
of Intellectual Property (AIPPI), the Association of University
Technology Managers (AUTM), the Fédération Internationale
des Conseils en Propriété Industrielle (FICPI) and the Licensing
Executives Society International (LESI), and with the assistance
from the WIPO Economics and Statistics Division.
6
les Nouvelles
WIPO Arbitration and Mediation Center
The WIPO Center2 promotes, on a not-for-profit
basis, the resolution of international commercial
disputes between private parties through Alternative
Dispute Resolution (ADR) mechanisms, including
arbitration, mediation and expert determination.
It administers proceedings under the WIPO Mediation Rules, the WIPO Arbitration Rules, the WIPO
Expedited Arbitration Rules and the WIPO Expert
Determination Rules.3 While these WIPO Rules are
appropriate for all commercial disputes, they contain provisions on confidentiality and technical and
experimental evidence that are of special interest
to parties to IP disputes. To date, the WIPO Center
has administered over 350 cases, with a 27 percent
increase of its caseload in the past 3 years.
The following diagram shows the split in the cases
administered by the WIPO Center among the different procedures:
Figure 1. Cases Administered By
The WIPO Center
Arbitration
24%
Expedited
Arbitration
19%
Mediation
57%
Source: WIPO Arbitration and Mediation Center
2. Information on WIPO Center is available at: http://www.
wipo.int/amc/en. For details on the history of the creation of the
WIPO Center, see: Development of WIPO’s Dispute Resolution
Services, World Intellectual Property Organization, 1992-2007,
Part III, pp. 93-104, www.wipo.int/amc/en/history/.
do 40 percent of WIPO (expedited) arbitration cases.
See Figure 2.
The increasing awareness and use of WIPO ADR is
reflected by the incorporation of the WIPO Center’s
clauses in model agreements, such as the DESCA
(Development of a Simplified Consortium Agreement for the Seventh Framework Programme (FP7))
model consortium agreement, which has been developed for multi-party collaborations in the area of
research and development and which recommends
WIPO Mediation Followed, in the Absence of
■ Judith Schallnau,
a Settlement, by WIPO
World Intellectual Property
Expedited Arbitration.5
Organization, Arbitration
Also, the Intellectual
and Mediation Center,
Property Agreement
Legal Officer,
Guide (IPAG), 6 which
Geneva 20, Switzerland
provides model agreeE-mail: [email protected]
ments for non-disclosure
agreements, research
■ Russell Levine, P.C.,
contracts, research and
Kirkland & Ellis LLP,
development framework
Partner,
contracts, material transChicago, IL, USA
fer agreements, patent
E-mail: russell.levine@
licenses and intelleckirkland.com
tual property purchase
agreements, includes WIPO Expedited Arbitration as
stand-alone ADR dispute resolution mechanism, and
WIPO Mediation followed, in the absence of a settlement, by WIPO Expedited Arbitration. Further, the
use of WIPO ADR has been publicly recognized, for
example, in the modified Final Order of the Federal
Trade Commission involving Motorola Mobility LLC
and Google Inc., issued
on July 23, 2013, which
Figure 2: WIPO Mediation Settlements
mentions arbitration, in-
The subject matter of the mediation and arbitration cases so far administered by the WIPO Center
includes patent, know how and software licenses,
franchising agreements, trademark coexistence
agreements, distribution contracts, joint venture
agreements, research and development contracts,
technology transfer agreements, technology-sensitive
employment contracts, mergers and acquisitions
with important intellectual property aspects, sports
marketing agreements, and publishing, music and film
contracts, as well as cases arising out of agreements
in settlement of prior court litigation.
Parties in cases administered by the WIPO Center
so far are based in Asia, Europe and North America.
Of those parties, 32 percent are involved in the IT
sector, 14 percent in pharmaceuticals, biotechnology and life sciences, 16 percent in mechanical, 10
percent in entertainment, 4 percent in luxury goods
and 1 percent in chemicals. The remaining 23 percent
are involved in a range of other areas. The amounts
in dispute range between EUR 15,000 Euros and
USD 1 billion.
Seventy-six percent of mediation and arbitration
cases administered by the WIPO Center are based on
dispute resolution clauses4 included in existing agreements between the parties stipulating that future
disputes shall be submitted to WIPO mediation and/or
(expedited) arbitration. The remaining 24 percent of
mediations and arbitrations are based on agreements
specifically submitting an existing dispute to WIPO
mediation or (expedited) arbitration. Such disputes
relate, for example, to patent infringement.
Sixty-nine percent of WIPO mediations settle, as
Mediation
Settlement
69%
Non-Settlement
31%
Source: WIPO Arbitration and Mediation Center
Arbitration
Settlement
40%
Non-Settlement
(Award)
60%
3. A general description of
the procedures administered
by the WIPO Center can be
found in an article published
by the WIPO Center in Volume
XLII No. 1 (March 2007) of les
Nouvelles (http://www.wipo.
int/export/sites/www/amc/en/
docs/nouvellesmarch2007.pdf).
4. Recommended WIPO
Contract Clauses and Submission Agreements: http://
www.wipo.int/amc/en/clauses/
index.html.
5. DESCA model agreement:
http://www.desca-fp7.eu/.
6. IPAG model agreements:
www.ipag.at.
March 2014
7
cluding WIPO arbitration, in relation to a dispute on
licensing Google’s standard-essential patents on fair,
reasonable, and non-discriminatory (FRAND) terms.7
Comments by Russell E. Levine
Based on my experience and on experiences
that others have shared with me, I believe that
administered ADR mechanisms are far better
than non-administered procedures. The WIPO
Center in particular has several advantages over
other arbitral institutions, including locations
in Geneva and Singapore and its status as an
international agency. Since the WIPO Center
is a not-for-profit organization, its cost structure is very competitive, and in my experience,
lower than other arbitral institutions. The WIPO
ECAF system, which allows parties and others
involved in a case to submit communications
electronically into a secured online docket,
helps make the overall process extremely efficient. The WIPO database has over 1,500 IP
arbitrators/mediators with expertise in all areas
of technology, and from over 70 jurisdictions.
Another advantage, in my view, of the WIPO
Center is its long history and experience. It was
established in 1994 to promote the resolution
of IP and related disputes and over the years
has developed and refined a comprehensive
set of rules and procedures, including rules for
expedited arbitration.
About the Survey
The Survey was distributed to companies, research
organizations, universities, government bodies, law
firms, individuals and other entities involved in technology transfer and technology disputes worldwide.
Its findings are based on the 393 responses received
by the WIPO Center from small (employing 1-10 people) to large entities (employing over 10,000 people)
in 62 countries and operating in many different business areas, including pharmaceuticals, biotechnology,
information technology, electronics, telecommunications, life sciences, chemicals, consumer goods
and mechanical engineering. In addition to written
submissions, over 60 interviews were conducted by
telephone with stakeholders in 28 countries.
Participants provided information about the types of
technology-related agreements which they concluded
7. Modified Final Order of the Federal Trade Commission issued July 23, 2013: http://www.ftc.gov/os/caselist/1210120/130
724googlemotorolado.pdf.
8
les Nouvelles
in the past two years, the types of disputes arising
from these agreements, the methods used to resolve
them and the reasons behind this.
“The survey confirms that parties to technologyrelated agreements are worried about the high
costs and lengthy timelines of disputes, especially
in an international context,” noted WIPO Director
General Francis Gurry at the launch of the survey
report. “While court litigation remains the default
path, survey responses indicate that ADR offers attractive options in terms of cost and time, as well as
enforceability, quality of outcome, and confidentiality,” he added.
The WIPO Survey results are consistent with
what I have seen in my practice and what I have
heard at LES local chapter meetings, LES (USA
& Canada) annual and mid-year meetings, and
LESI meetings. There is significant and growing
interest in exploring alternatives to litigation.
Companies large and small, public and private,
and domestic and foreign are all considering
alternatives to litigation to resolve disputes, and
are putting ADR clauses into license agreements,
joint development agreements, and other agreement involving and relating to IP. Almost every
settlement agreement and license agreement that
I have been involved in this year has included an
ADR clause. If the parties are both U.S. parties,
the preference is for mediation and/or arbitration
utilizing a U.S.-based administrator, such as JAMS
or CPR. In one agreement, in the electronics industry, the parties also specified the city in which
the mediation was to occur so as to reduce travel
costs for both sides.
I have seen an even greater interest in ADR
clauses when the parties to the agreement being
negotiated are based in different countries. In a
recent license deal in the automotive industry, the
licensor was based in Europe and the Licensee
was based in the U.S. Understandably, neither
wanted a dispute to be resolved via litigation in
the home country of the other, so they selected
arbitration in a neutral location.
The type of entity has an impact on the willingness to use an ADR mechanism. For example,
universities, research institutes, and smaller
companies tend to favor mediation and arbitration. These entities in particular are sensitive to
costs, and simply may not have the resources
necessary to withstand lengthy litigation.
Agreements and Occurrence of Disputes
Choice of Dispute Resolution Clauses
Of the types of agreements listed in the Survey,
participants mostly frequently concluded non disclosure agreements (NDAs), followed by assignments,
licenses, agreements on settlement of litigation,
research and development (R&D) agreements and
merger and acquisition (M&A) agreements. Reflecting
the globalized business landscape, over 90 percent of
participants indicated they had concluded agreements
with parties from other jurisdictions, and 80 percent
had concluded agreements relating to patents granted
in several countries. The choice of applicable law
made in these agreements was influenced especially
by the location of the participants’ headquarters and
the primary place of their operations.
The Survey showed that while, overall, disputes
occurred in relation to some 2 percent of participants’ technology-related agreements, licenses most
frequently gave rise to disputes (among 25 percent
of participants). R&D agreements ranked second
(among 18 percent participants), followed by NDAs
(16 percent), settlement agreements (15 percent),
assignments (13 percent), and M&A agreements
(13 percent). Licensing disputes concerned issues
such as the scope and existence of a license, quality
standards, profits and determination and payment of
royalty rates.
WIPO Center Experience: This reflects the experience of the WIPO Center with 42 percent of the
technology-related cases handled by the WIPO Center
relating to licenses, 7 percent to R&D agreements and
2 percent to settlement agreements.
While there is a general perception that negotiations of dispute resolution often play a very limited
role, 94 percent of respondents confirmed that they
negotiate dispute resolution clauses as part of their
contract negotiations. The most commonly negotiated
stand-alone dispute resolution clause provides for
court litigation (32 percent), followed by (expedited)
arbitration (30 percent) and mediation (12 percent).
Mediation is also included where parties use multitier clauses (17 percent of all clauses) providing for
mediation prior to court litigation, (expedited) arbitration or expert determination. Where ADR is used, the
choice of arbitral institution broadly corresponds to
the location of respondents’ headquarters.
WIPO Center Experience: Sixty-six percent of
WIPO cases have been based on stand-alone dispute
resolution clauses out of which 38 percent provided for
arbitration, 25 percent for expedited arbitration and 38
percent for mediation. In 34 percent of cases parties
included multi-tier dispute resolution clauses providing for mediation, followed by (expedited) arbitration.
ADR can be particularly useful to expeditiously
resolve disputes involving so-called Most Favored Nations (MFN) provisions. Such disputes
often arise when the licensee believes that the
licensor has granted a license to a third party
with a more favorable royalty rate or more favorable terms and conditions, and the licensee
believes that, pursuant to the MFN clause in
its agreement, it is entitled to the benefit of
this allegedly lower rate and/or more favorable
terms. ADR also can be useful to expeditiously
resolve disputes regarding whether second and
subsequent generation products are “Licensed
Products” and thus subject to the royalty provisions in the agreement. I have also seen ADR
used to quickly resolve disputes relating to
assignment clauses and disputes relating to
audit rights.
One advantage of contractual-based ADR is that
the parties can structure the ADR process to best
suit their dispute resolution needs. For example,
the parties can limit the issues, limit the amount
and type of discovery, and limit the length of
the hearing. The parties also can specify certain
characteristics an arbitrator should have such
as a B.S. (Bachelor of Science) in Electrical Engineering or a familiarity with U.S. Patent law.
I have seen clauses that require the arbitrator
to issue a written decision within 60 days of
submission of the last post-hearing brief and
numerous other clauses all agreed to by the
parties at the time the agreement was entered
into, and all having the effect of expediting and
reducing the cost of dispute resolution.
When asked about trends, respondents generally
confirmed a trend towards out-of-court dispute resolution mechanisms.
I have often been asked by clients and others about trends in the use of ADR and, prior
to the WIPO Survey, obtaining broad-based
information and statistics on such trends had
proven difficult. The Survey has some of the
March 2014
9
ADR process,” or, with the parties’ consent,
“may refer any civil case to binding arbitration,
binding summary jury trial or bench trial, or
other binding ADR process.” The timing of
such referrals is left to the discretion of the
district judge. The rules contain extensive
provisions requiring the parties’ to consider
ADR at the Early Planning Conference, the
selection of an ADR neutral, the submission
of required documents and memoranda, the
procedures to be followed at the conference
(including attendance by both lead counsel
and the clients), reporting back to the district
judge, and ADR fees. The Northern District of
Illinois requires, in the form Report of the Parties’ Planning Meeting incorporated into the
district’s Local Patent Rules, the identification
of “any alternative dispute resolution procedure that may enhance settlement prospects.”
The International Trade Commission’s rules
permit Administrative Law Judges hearing Section 337 patent infringement investigations to
direct the parties to discuss settlement.
most comprehensive data that I have seen and
it sheds light on the current trends in a wide
range of industries and from across the globe.
In the U.S., one reason for the growth in the
use of ADR are Court Orders requiring the
parties to participate in an ADR mechanism.
The Alternative Dispute Resolution Act of 1998
requires federal district courts to authorize, by
local rule, the use of at least one ADR process in
all civil actions. As a result, most district courts
have adopted such rules and increasingly are
requiring or encouraging parties to engage in
ADR or at least to have discussions about ADR.
For example, the Northern District of Georgia’s
Local Civil Rules (as well as the local civil rules
of many other district courts) include an ADR
provision “for the resolution of civil disputes
with resultant savings in time and costs to litigants and to the court, but without sacrificing
the quality of justice or the right of the litigants
to a full trial in the event of an impasse following ADR.” The district judge “may in his or her
discretion refer any civil case to a non-binding
Figure 3: Main Considerations When Negotiating Dispute Resolution Clauses
71%
71%
Costs
50%
60%
Time
Enforceability
52%
33%
44%
45%
Quality Outcome (Including Specialization of
Decision-Maker)
Neutral Forum
36%
18%
32%
33%
Confidentiality
29%
30%
Business Solution
9%
6%
Support Provided by Institution
5%
8%
None in Particular (Standard Internal Practice)
5%
6%
Setting Precedent
0%
10%
20%
30%
40%
50%
60%
70%
Percentage of Respondents
Domestic Agreements
International Agreements
Source: WIPO Arbitration and Mediation Center, International Survey on Dispute Resolution in Technology Transactions
10
les Nouvelles
80%
Prime Considerations for Dispute Resolution
Mechanisms
Cost and time are the prime concerns when negotiating dispute resolution clauses, both in domestic
and international agreements. The Survey shows that
for international agreements, other considerations
include enforceability and forum neutrality. Finding
a business solution, however, is the prime objective
of those focusing their dispute resolution strategy
on mediation, both for international and domestic
agreements. See Figure 3.
Objectives in Patent Disputes
While the main objectives of claimant parties in
patent disputes were to obtain damages/royalties (78
percent), a declaration of patent infringement (74
percent), and/or injunctions (53 percent), respondent
aimed at declaration of patent invalidity (73 percent),
a negative declaratory judgment (33 percent), and/
or a declaration of patent infringement (33 percent).
The need for an ADR mechanism in patentrelated disputes, and for an ADR clause in
patent-related agreements, is in my view greater
than when dealing with other types of IP rights.
The complexity of patent-related disputes often
results in lengthier and more costly litigation
as compared to copyright or trademark litigation, for example. As the Survey results show,
costs and time are the two main considerations
when negotiating dispute resolution clauses
and a properly structured ADR mechanism can
reduce the time and cost needed to resolve a
dispute. For example, I recently represented a
party in the automotive industry in litigation
with its primary competitor. The settlement
agreement included an escalating dispute resolution mechanism that started with discussions
between executives and concluded if necessary
with a binding arbitration. In their effort to
control costs and to speed up the entire process, the parties agreed that any future patent
dispute had to be initiated within a set time
period triggered by the issuance of the patent
or introduction of the accused product. The
parties also limited the issues to infringement
and validity, and prevented issues of willfulness
or inequitable conduct from being raised in
the proceeding.
WIPO Center Experience: Some 40 percent of
the WIPO Center ’s arbitration and mediation
cases relate to patents. In these cases—almost
all of which are contractual—requested remedies
include damages, royalty payments, declarations of
non-performance of contractual obligations and/or
of patent infringement, a declaration of unenforceability of a patent against a licensee, or, principally
in mediation, entering into a contract.
Figure 4: Relative Use Of Court Litigation, (Expedited) Arbitration,
Mediation, Expert Determination
Expedited Arbitration
Expert Determination
Court Litigation
Foreign Jurisdiction
Mediation
Arbitration
CONTRACTUAL
Court Litigation
Home Jurisdiction
50%
0%
FREQUENCY
50%
Arbitration
Mediation
Court Litigation
Court Litigation
Home Jurisdiction
NON-CONTRACTUAL
March 2014
11
Figure 5: Relative Time And Costs Of Resolving Disputes Through Court Litigation,
(Expedited) Arbitration, Mediation, Expert Determination
Mediation
Court Litigation
Home Jurisdiction
Arbitration
Court Litigation
TIME
TIME
COST
COST
Mediation
Arbitration
Court Litigation
Home Jurisdiction
Court Litigation
How Disputes Were Resolved
Broadly consistent with the Survey findings concerning the choice of dispute resolution clauses,
the most common mechanism used to resolve
technology disputes was court litigation in both
home and foreign jurisdictions followed by arbitration, mediation, expedited arbitration and expert
determination. See Figure 4.
Time and Costs
The respondents spent more time and incurred
significantly higher costs in court litigation than in
arbitration and mediation. The estimated duration of
court litigation in a home jurisdiction was on average
3 years and costs around U.S. $475,000. Litigation
in another jurisdiction takes around 3.5 years with
legal fees of just over U.S. $850,000.
In contrast, the Survey shows that mediation takes
on average 8 months, and in the majority of cases
costs less than U.S. $100,000. Arbitration takes on
average just over a year and typically costs around
U.S. $400,000. See Figure 5.
WIPO Center Experience: By comparison, in the
WIPO Center’s experience, mediation under WIPO
Rules takes on average 5 months and costs on average U.S. $21,000. Arbitration cases under the WIPO
Expedited Arbitration Rules on average take 7 months
and cost around U.S. $48,000 and cases under the
WIPO Arbitration Rules, often involving patents
12
les Nouvelles
protected in several jurisdictions, on average take 23
months and cost some U.S. $165,000 (48 percent of
such cases involving a three member tribunal and 52
percent a sole arbitrator).
On top of the monetary costs, dispute resolution
also ties up the time of business executives and others
participating in the proceedings. Involvement in such
disputes can also translate into reduced productivity
and missed business opportunities.
Comments By Russell E. Levine
I agree with the WIPO Survey results. Mediation
is faster and less expensive than arbitration and
both are faster and less expensive than litigation.
In a recent arbitration in which I represented
the respondent, the arbitration hearing was
held seven months after the complaint was filed
and the arbitrators decision issued one month
later. I have found that the recipe for success in
arbitrations is not that different from how we
prepare for jury trials in the U.S. Indeed, good
arbitration practice is not much different from
good trial practice, although more emotional
jury persuasion techniques are generally less
effective and can even be counterproductive
before a panel of experienced judges or patent
litigators serving as arbitrators.
For mediation in the U.S. and with U.S.-based
companies, a few tried-and-true practices
generally make the process more likely to end
successfully:
1. Bring a decision maker from the client
and include him or her in the preparations.
Many mediators, especially magistrate judges,
expressly require this. You should feel free to
allow the decision maker to meet directly with
his or her counterpart or with the mediator. If
you have undertaken all necessary preparations,
there is nothing to fear and much potentially to
be gained. In a case I mediated years ago in the
District of Delaware, involving back-end, financial transaction technology, the other side did
not send the decision maker. The person they
sent “agreed” to a proposed deal, the Magistrate
Judge, who was the mediator, told the District
Court Judge that the case had been settled and
the parties went back home while the lawyers
stayed to draft the final settlement agreement.
The following day, the Magistrate Judge received
a call from the person the other side had sent
and was told that the proposed deal had been
rejected by senior management, as had the entire deal structure. Instead of a running royalty
structure, the other side now wanted a lump
sum structure. Needless to say, the dynamics of
the mediation dramatically changed.
2. Focus on what you need, not what you want.
Mediation is not the time to “win.” There is
nothing wrong with tough negotiating, but set
a goal that you can live with and aim for it.
3. Leave emotions at the door. Where the parties
have a personal or professional animosity toward
each other, this can be difficult. In those cases,
sometimes a bit of “venting” can be therapeutic and beneficial if properly managed by an
experienced mediator who can keep things in
hand. Ultimately, though, mediation is a business negotiation and should be treated as such.
Labeling the other side, even internally, as a
“patent troll,” “thief,” or “heartless corporation”
is never productive.
4. Think carefully about opening statements.
It is usually a waste of time to use an opening
statement to try to “convince” the other side
or a mediator, especially one using a facilitative
approach, of the rightness of your case. Where
an opening statement can be helpful, however,
is in demonstrating to the opposing client that
you are prepared to litigate, know your case,
and can advocate persuasively. But, in most
cases, the parties know that the other side is
prepared and has quality lawyers and thus, open-
ing statements tend to create emotions and can
be counter-productive to the process. Unless
there is a very good reason to have opening
statements, I believe that the best practice is
to dispense with them.
5. Avoid scheduling multiple sessions in advance. Schedule one and go into it with as
much optimism as possible. Negotiations tend
to work better if there is a deadline and a sense
of “crunch time.” Moreover, if multiple sessions
are scheduled, say months apart, the early sessions tend to become “smoking out” sessions
and parties tend to hold back to see if they can
push for more from the other side. Certainly
if progress is being made, the parties should
schedule another session, but that is something
that should be done at the end of the day, not
prior to the start of the mediation.
6. Select a mediator who is willing to get, and
stay, involved. Many mediators take great pride
in their settlement rates and will do whatever
it takes to get the case resolved.
7. Memorialize any agreement in a written
term sheet. This should include not only payment terms, but license scope, confidentiality,
and other such provisions, to avoid a deal later
blowing up over what the parties assumed
they could later work out. Of course, if it is
feasible to prepare the definitive settlement
agreement while all parties are present, it is
preferable to do so.
Some Observations
It is clear that no one dispute resolution mechanism
can offer a comprehensive solution in all circumstances. Indeed, each transaction is likely to have its
own dispute resolution requirements. It is for the
parties involved to assess the specific circumstances
of a transaction and to determine the most appropriate way to resolve any disputes that may arise. The
Survey, however, does offer some useful guidance
for those involved in developing dispute resolution
strategies. Key insights include:
•The need to anticipate the risk of disputes in
contracts. Although dispute resolution provisions
are often regarded as a relatively minor element in
contract negotiations, the time and costs associated
with any subsequent dispute means that parties
cannot afford to ignore this aspect.
•The need to take account of the risk of foreign
litigation and anticipate the international nature of
the parties, rights and law involved.
March 2014
13
•The cost of court litigation in a foreign jurisdiction, and sometimes in a home jurisdiction, typically
exceeds that of ADR mechanisms. When crafting
dispute resolution strategies, it is therefore important while taking account of the specifics of a given
transaction, to focus on keeping costs and time to
a minimum.
•Mediation can be a valuable part of a dispute resolution policy, with high settlement rates yielding
significant time and cost savings. Adding arbitration
as a next step in a multi-tier approach can enhance
the chances of settlement if mediation fails.
•In relation to international patent disputes, which
have important time and cost implications, when
deciding whether to opt for court litigation or ADR
mechanisms, it is important to take account of any
existing specialized courts and judges, bifurcation
of proceedings, availability of injunctions, possible
parallel litigation, and enforceability.
The WIPO Survey shows that ADR has become
more common in resolving patent infringement,
patent license and other technology-related
disputes. This trend will continue as more and
more agreements contain ADR clauses. In my
opinion we also will continue to see parties
agree to move existing litigation matter out of
court and into an ADR process. In this regard,
there is always a tension in determining the
most effective time to move the case from court
to ADR or to stay the litigation while utilizing
an ADR mechanism. When ADR is done early,
the cost savings are greatest and the parties are
generally less entrenched in their positions and
have had less opportunity for the case to have
become “personal.” On the other hand, however, the parties will have had less opportunity
to gather necessary information to evaluate
their position. While this is less of an issue in
binding arbitration, in which the arbitration
process itself may allow for discovery, depending
in particular on the law of place of arbitration
and the parties’ agreement), when mediation
or expert determinations are used, a process
14
les Nouvelles
that occurs too early may be less fruitful. In my
experience, if the parties are using mediation or
expert determinations, an ideal time is usually
following the exchange of infringement, invalidity, and (if applicable) non-infringement contentions, along with the accompanying document
productions, but before any depositions or
significant document production. This generally
allows the parties to gain enough information
about the merits of the case without incurring
the most significant discovery expenses or the
cost of claim construction briefing and a claim
construction hearing. Some limited amount
of damages discovery (often in the form of an
exchange of summary charts) also is helpful. If
the case is likely to turn on a claim construction
argument, the parties may want to consider a
non-binding claim construction on one or two
key terms by the arbitrator or mediator.
The type of ADR most likely to be successful will
vary depending on the nature of the dispute and
the dynamics of the parties. It is important to
think these issues through. If the parties seem
to recognize that there are merits to both sides
of the case, or if the parties have an ongoing
business relationship, mediation may be the best
choice. If the parties are both highly certain that
they will win at trial and antagonistic toward
any negotiation, arbitration might be a better
option. Even within the options of mediation,
expert determinations, or arbitration, a number
of additional options, and even different styles
of neutrals and procedures, are available and
should be considered. Whatever process is
selected, it is important to document the decision between the parties, addressing such issues
as whether the process will be binding, how a
neutral will be chosen, confidentiality, appeal
rights, the issues that will be addressed, etc.
And, rather than re-inventing the wheel, the
parties likely would be far better off designating
an arbitral institution, such as WIPO’s Arbitration and Mediation Center, and using its rules
and procedures. ■
IP In Academic Environments
Patent Technology Landscapes For Assessing
Intellectual Property In Academic Environments
By Joe Wyse, Ken Zinda, Greg Gerhardt, Bob Gregory and Eric A. Grulke
Abstract
The patent technology landscape is an analytical
tool widely used in industry to assess the value of and
guide the development of intellectual property (IP)
into commercial products and processes. Although
academia increasingly faces the similar need to assess commercial potential of university-created IP, the
tool has not been used in university settings because
it requires third party data inputs and experienced
analysts who are more typically used by industry. This
project demonstrates how the tool could be used
in academic technology development and transfer
planning, initially with assistance of consultants. This
patent technology landscape process, modeled after
the Inspherion (Cleveland, Ohio) analysis methods,
included building a hierarchical structure of a invention, connecting its attributes with market needs,
perceiving potential markets for the technology, and
constructing a matrix of the landscape to help visualize
patent activity and relationships. An advanced stage
translational research project was used as a test case.
This patent technology landscape approach improved
the definitions of technology attributes, identified new
potential markets, clarified the research activities of
potential collaborators and competitors, and identified new, shorter pathways toward commercialization. All of these outcomes address critical needs for
university decision-makers responsible for allocating
scarce academic resources. In addition, using such a
landscape would help faculty and students by providing
a structured approach for understanding translation
processes that can lead from discovery to commercialization. The landscape can help identify opportunities
for academic—academic, academic—startup, and
academic—industry collaborations.
Introduction
Challenges for Assessment of Academic Research
Leading to Commercialization
ranslating bench-scale research into clinical
practice is becoming increasingly important for
scientists and administrators in the medical and
life sciences sectors. Such efforts can be particularly
challenging for academic research teams, which often
have few contacts, modest experience, and limited
T
opportunities to conduct activities leading to the
commercialization of innovations. Guiding research
translation can also be challenging for university administrators charged with IP evaluation and economic
development. Universities, now in an era of scarce research resources, may be trimming resources devoted
to assessing the potential
of their intellectual prop■ Joe Wyse,
erty and to ensuring that
Wyse Innovations,
their commercialization
President,
processes link to their
Lexington, KY, USA
academic missions. ComE-mail: jwyse@
mercialization facilitated
wyseinnovations.com
by academic structures,
such as offices of eco■ Ken Zinda,
nomic development, can
Inspherion Inc.,
be realized in a variety
President,
of forms, from entreCleveland, OH, USA
preneurship of spin-off
E-mail: ken.zinda@
companies to licensing
inspherion.com
technology with established corporate partners.
■ Greg Gerhardt,
But for commercializaUniversity of Kentucky
tion to be successful,
Medical Center,
economic development
Professor and Director
offices need to handle
for Microelectrode Technology,
a number of formidable
Lexington, Kentucky, USA,
tasks, such as:
E-mail: [email protected]
• Sizing the market
and identify potential
■ Robert Gregory, PhD,
applications;
University of Kentucky
• Identifying potential
College of Engineering,
licensees;
Proposal Development Officer,
• Developing business
Lexington, Kentucky, USA
strategies for commerE-mail: [email protected]
cialization of the technology;
■ Eric A. Grulke,
• Assessing values of
University of Kentucky,
specific licenses, liAssociate Dean,
cense terms, and their
Research and Graduate Studies,
business strategy;
Lexington, Kentucky, USA
• Understanding scaleE-mail: [email protected]
up and manufacturing
options; and
March 2014
15
Table 1. Challenges When Implementing Patent Landscapes
In An Academic Environment
Patent landscape objective
Implementation challenges for an academic environment
Understanding the landscape
Assessment of technology deserts is practical while jungles may require
excessive resources.
Identifying and understanding recent trends
Academic inventors may miss economic, social, and business trends.
Obtaining team expertise for manufacturing,
regulatory, and business issues
Not all of these elements may be locally available for the review process
or within the academic research team.
Estimating freedom-to-practice
Appropriate evaluation experience may be missing at the
academic institution.
Leveraging related intellectual property
Co-opting and collaboration require excellent knowledge of the
business community.
• Evaluating options for commercialization, such
as company formation, long-term patent portfolios around the technology area, and the services
needed to support such efforts.
However, university IP programs often face a wide
range of what are, by definition, new and thus unfamiliar technologies; staff may have limited experience
either with specific target market placements or with
setting realistic expectations for the wide range of IP
generated by large universities.
Commercialization in Typical
Academic Environments
At many universities, technology transfer offices
review invention disclosures in relative isolation from
the business and market environments for potential
commercial products. The reviews, often conducted
by a faculty committee, tend to focus on a single
factor—disclosure novelty (e.g. contribution to the
field) based on patent and archival literature. A tool
for evaluating intellectual property should go beyond
disclosure novelty. It should be ‘neutral’ with respect
to technologies (to reduce the tendency to over- or
under-estimate the value of the specific invention);
it should show the scope of related work, identify
relevant technology trends, and their intensities; it
should suggest freedom-to-practice; and evaluate all
potential markets (especially those that may not have
been considered by the inventors themselves). Now,
the overriding challenge for academic environments is
not just to innovate, but to create value for industry,
which, in turn, will create value for the university.
Patent landscapes. Life science companies commonly use patent landscapes for strategic planning
[1]. Examples of patent technology landscape applications include assessing freedom-to-operate [2] [3],
evaluating intellectual property associated with the
human genome [4, 5], comparing stent thrombosis
16
les Nouvelles
[6], and medical devices [7, 8]. Patented technology
landscapes can be used to understand the technology
environment, identify recent trends, explore close
out issues, estimate freedom-to-practice, and uncover
other intellectual property that can be leveraged. Activity in technology areas is generally categorized in
terms of its published patent density: as a desert (<
10 patents), a grassland (10 to 100 patents), a forest
(100 to 1000 patents), and a jungle (> 1000 patents).
In academic environments, it is likely that ‘desert’
patent landscapes will be more easily investigated
than ‘jungle’ patent landscapes, because landscapes
requiring analysis of high volumes of information
will require more resources for the analyses. Table
1 lists challenges for implementing patent technology landscapes analytics in academic environments:
these challenges are linked to the previous list of
commercialization needs.
Patent Technology Landscapes for Academic
Environments
The Contextual View of IP Development
Managers of academic IP need to determine the
position of a specific project within a broader patent
technology application landscape. For example, what
do the patent rights represent to the marketplace?
The traditional linear model for commercialization pathways assumes series workflow from basic
research through concept validation and development to commercialization. By contrast, activities
associated with current commercialization pathways
should be visualized as a network with nodes of research, products, and patents connected in complex
patterns (Figure 1). The milieu includes products,
patents, applied research, and fundamental research.
Information flows in the network are complex and
can occur in all directions. Collaborative partnerships and cross-licensing arrangements can con-
Figure 1. Network Model Of Innovation
Applied
Research
Applied
Research
Product
R&D
Patent
R&D
Patent
Applied
Research
Product
Applied
Research
R&D
Patent
Product
Patent
Applied
Research
Product
R&D
R&D
Applied
Research
R&D
Patent
Product
Product
Patent
tribute significant accelerations or can expand the
innovation ecosystem.1
Our case study focuses on applications of a novel
multisensory probe for neurological treatments and
disorders, an interoperative chemical diagnostic device. This patent technology landscape process was
used to identify potential technology “white spaces”
(areas with low levels of activity), to quantify the patent activity of major medical device manufacturers in
this landscape, and to uncover potential collaborative
opportunities. Once the landscape was understood,
product development activities within the academic
laboratory could be prioritized. Figure 2 shows the
patent technology landscape process used in this work.
The process steps are: select a visualization method for
the landscape; develop the search structure and terms;
perform the search; and analyze the results.
Visualization method. In this case, we chose a
two-dimensional matrix of utility attributes and application markets [9] for the interoperative chemical
diagnostics device, establishing the structure for the
patent search process and the resulting graphical
landscape.
Developing the search method. There are two
steps for this element: deconstructing the medical
device into subsystems and linking those to performance attributes and markets, and generating search
terminology for all matrix elements pairs (attribute:
market). The search terminologies describe all at-
Figure 2. Patent Technology
Landscape Process
Select Visualization Method
2D matrix of attributes and markets [9]
Develop Search Structure
1. Elements of an innovation ecosystem for a specific technology include the knowledge portfolio (intellectual property, basic
science, and technology), the institutional components that support this portfolio (academic, industrial, finance, and manufacturing), the learning capacities of the ecosystem team members
(the mission and vision links, the resources, and the infrastructure), and the network of connections between them. [9]
Goldstein, H. and J. Drucker, “The economic development
impacts of universities on regions: do size and distance matter.”
Economic Development Quarterly, 2006. 20: p. 22.
Deconstruct the innovation (Hierarchy of Innovation)
Generate search terminology
Search
Simple (patent databases) or Advanced (special services)
Analyze
Measurands
Outcomes
March 2014
17
Figure 3. Hierarchy Of Invention: Interoperative Chemical Diagnostic Device
Hierarchy of
Invention
Disorder Type
Brain Disorders
End-Product
Market
Application
Disorders
Tumors
Epilepsy
Traumatic Brain Injury
Neuro Degerenerative
Disease
Nerve Stimulation
Acute CNS Diagnostic
Brain Neuro Sensors
Migraine
Mood Disorder/
Depression
Chronic CNS
Diagnostic
Signal Channels
Function
Device Reporter
Device Channels
CNS Signaling
Devices
Diagnostic Instrument
Device
Components
Electrode
Component
Attributes
Perfected Analytes
Attribute
Conceptual Analytes
Untested Analytes
Diagnostic Ratios
CNS Pattern 1
CNS Pattern 2
Device Coating
tributes, functional forms, applications, and markets
of interest. The search algorithm then identifies
documents with specific pairs of attribute:application
terms, i.e., representing a specific matrix element in
the landscape. The patents identified for each matrix
element constitute a frequency subset that is then
subjected to measures.
The Hierarchy of Invention2 framework was used
to deconstruct the innovation; it illustrates how different invention systems and elements are integrated
to provide solutions to market needs. A Hierarchy of
Invention sketch deconstructs the device into three
aspects: functions, systems, and components. These
device elements are then linked to attributes (or
specifications) and the relevant applications (or markets served). The interoperative chemical diagnostic
device used to test the approach has been used in
clinical trials linked to tumors, traumatic brain injury, epilepsy, and neuro-degenerative diseases. Its
structure includes:
• A ceramic probe with a precise positioning
system;
2. The Hierarchy of Invention is a methodology developed by
Inspherion and is used by permission.
18
les Nouvelles
Brain Metabolics
• A sensor system with multi-channel microelectrodes (4-24);
• Enzymatic reporter systems in sterilized, crosslinked matrices to prevent enzyme leaching; and
• A set of analyte detection systems that can be
patterned on the ceramic probe, some of which
are robust (demonstrated via clinical trials) and
others of which are under development.
The performance attributes form the base of the
sketch of the hierarchy (Figure 3). The applications
are shown at the top of the sketch, and are connected
to the attributes by the device structure. Figure 3
helped the academic research team visualize the
relationships between device structure, the market
attribute or attributes that link to its specification(s),
and potential market applications.
Search algorithms. A key objective for this case
study was to identify new potential markets for the
interoperative chemical diagnostics device.
Analysis. Our analysis was based on a set of measurands for the published patent data and leading
indicators that describe patenting activity within the
landscape.
Innovation measurands. The measurands used to
describe innovations in the analysis were patents per
matrix element, the number of elements to which one
specific patent was linked (defined as the innovation
metric (IM)), the maximum value of the innovation
metric (IMmax), and the number of patents per element per year. IM and IMmax can be assessed for
specific companies and inventors, and with respect
to patent year. These measurands lead to a rich set
of leading indicators that can be used to explore this
patent technology landscape.
Leading indicators. The leading indicators used
for the evaluation of this patent technology landscape
were the technology activity, the technology maturity
(emergent, pacing, and mature), the company (assignee) focus areas within the landscape, company activity
levels, top innovators in the landscape, and, for one
case, a company ‘dashboard’ within the landscape.
Implementing the landscape. Consultants were
used to implement the process shown in Figure 2
as the academic research team had little experience
in such analyses. The consultants suggested the use
of an attribute-market matrix as the visualization
tool, and conducted extensive interviews with the
academic team to develop the search structure. The
Hierarchy of Innovation deconstruction accomplished
two objectives: improved definition of the innovation
(as it might be implemented commercially) and signifi-
cant expansion of the possible markets (from 4 to 11).
Specialized search software, previously developed by
Inspherion, was used for a very broad exploration of
the landscape. The leading indicator analysis was done
by the consultants, based on their experiences with
other patent technology landscapes. With training, it
is possible that academic team members can perform
some of these functions for future patent technology
landscapes. Going through the process is valuable
for both academic researchers and administrators; it
provides a clearer picture of how industry values IP.
Patent technology landscape results
Technology Activity
Table 2 illustrates the technology activity within
the landscape. Each matrix element has a unique set
of attribute/market descriptors. The patent search
identified over 17,000 unique documents (patent
applications and issued patents) from 1992 to 2012,
including documents for Europe, the U.S., and the
world. The number of documents for each matrix
element of Table 2 has been converted into quartiles.
These roughly correspond to the four categories
mentioned previously: desert, grassland, forest, and
jungle. The number range of documents within each
quartile is identified in the table title.
Table 2. Patent (Document) Activity
Analytes
Disease
1
2
Metabolism Patterns
3
4
5
6
Probe
7
8
9
10
11
A
B
C
D
E
F
G
H
I
J
Disease and attribute key: emergent = white, pacing = light blue, mature = blue.
Quartile ranges (number of documents per matrix element): first = 1 to 12, white; second = 13 to 53,
dots; third = 53 to 101, slanted lines; fourth = 102 to 3793, cross-hatching.
Analytes: 1=Perfected Analytes, 2=Conceptual Analytes, 3=Untested Analytes, 4=Diagnostic Ratios, 5=Brain
Metabolics, 6=CNS Pattern 1, 7=CNS Pattern 2, 8=Device Coating, 9=Device Channels, 10=Device Reporters,
11=CNS Signaling. Diseases (markets): A=Tumors, B=Epilepsy, C=Traumatic Brain Injury, D=Neuro-Degenerative
Diseases, E=Neurostimulation, F=Acute CNT Diagnostic, G=Brain Neuro Sensors, H=Migraine, I=Depression,
J=Chronic CNS Diagnostic.
March 2014
19
Table 2 shows significant patent activity with perfected (1) and untested analytes (3). These attribute
columns had greater than 1,000 patents in their
matrix elements. There is less patent activity in attributes of the device probe (8-11). The least patent activity is in the attributes of metabolism and metabolic
patterns (4-7). The matrix thus indicates significant
opportunities to develop meaningful patents and patent suites to protect intellectual property, particularly
with respect to central nervous system patterns. Four
potential markets, Tumor, Epilepsy, Traumatic Brain
Injury, and Neuro-Degenerative Diseases (rows A-D in
Table 2), show high levels of patent activity, possibly
indicating less room for new products. However, the
additional application areas identified during project
analysis (rows E-J) appear to have lower patent activity
levels for this device. Lower levels of patent activity
can indicate that one of these disease markets might
provide a more rapid commercialization pathway for
the technology based on higher freedom-to-operate.
Each patent is identified by research team(s) and year
as well as its descriptor set. Additional evaluation of
the data underlying this technology activity table was
used to infer technology maturity, market focus, and
company positioning.
Technology Maturity
Table 3 shows market and device attributes or-
ganized with respect to their activity levels over a
technology lifecycle: emergent, pacing, and mature.
Mature areas are those that show the most patent
activity, i.e., the cells in these rows or columns have
highest counts. Emergent attributes or markets have
columns or rows with the lowest counts. Note that
these quantitative assessments are relative. Another
indicator helpful in refining the analysis is the direction of the activity over time; that is, emergent attributes or markets often have increasing counts over
time, while mature attributes or markets might have
decreasing patent numbers over time.
We were most interested in the emerging markets
and device attributes, as these should provide more
rapid routes to commercialization of our device
technology and revenues streams that could fund
additional development for more complex markets.
Emerging device attributes included diagnostic ratios,
CNS patterns, and device coatings. Emerging market
applications included migraine, depression, and
chronic brain diagnosis. All emerging attributes and
applications were identified during the development
of the search structure (Fig. 2).
Company Emphasis Areas
In addition, the landscape process helped us
identify which companies dominate within specific
activity levels. Pfizer and Neurosearch are leading
Table 3. Patent Activities For Market And Device Attribute Categories;
Companies With High Activities In The Emergent, Intermediate, And Mature Areas
Emergent
Pacing
Mature
Market Applications
C. Traumatic Brain Injury
A. Tumors
B. Epilepsy
E. Neuro Stimulation
F. Acute CNS Diagnostic
D. Neuro Degenerative
H. Migraine
G. Brain Neuro-Sensors
J. Chronic CNS Diagnostic
I. Mood Disorder/Depression
Device Attributes
4. Diagnostic Ratios
2. Conceptual Analysis
1. Perfected Analytes
6. CNS Pattern 1
5. Brain Metabolics
3. Untested Analytes
7. CNS Pattern 2
10. Device Reporter
9. Device Channels
8. Device Coating
11. CNS Signaling
Company Rank Within Activity Level
20
Neurosearch
Pfizer
Pfizer
Pfizer
Neurosearch
Neurosearch
Abbott Laboratories
Astrazeneca
Astrazeneca
Ortho-McNeil-Janssen
University of California
Abbott Laboratories
Addex Pharmaceuticals
Medtronic
Merck
Schering
Wyeth
Merck
les Nouvelles
with respect to document count across the entire
landscape, followed by Ortho-McNeil-Janssen and
Astrazeneca. Abbott Labs has focused its innovation in
both mature and emergent areas within the landscape,
while Medtronic is concentrating on more emergent
topics. These rankings can provide a basis for selecting partners according to different commercialization
pathway choices.
High Activity Companies
The IM and IMmax measurands were used to infer
high patent activity by specific companies. A patent
that links to many matrix elements (its IM value is
relatively high) represents a revolutionary, integrative
contribution, with potential for great impact. The IM
measurand shows the level of integration between a
new idea and the prior art. By analyzing IM values
for large market/attribute datasets, we expect to
identify innovation trends, which are likely to be
motivated by market demand. IMmax values can be
used to identify leading research teams. Used in this
way, the measurands will also be useful to quantify
markets and attributes. Occasionally, very new ideas
may not be completely linked to their markets and
applications; in this case, an innovation metric would
be low because the innovative characteristics have
not been fully defined.
Within a market application or device attribute,
the innovation measurands can vary as the technol-
ogy moves from emergent to mature. As technology
becomes commercialized, corporate focus can shift
from invention to manufacturing, which often requires only incremental improvements. Therefore,
the yearly measurands for mature technologies may
be low, but their patent technology landscapes would
be highly populated over time.
For large datasets, patent activity is a proxy for continued R&D investment. By sorting companies based
on their patent document activity within specific time
frames, a ranking of the intensity of R&D investment
can be determined. An IMmax ranking reflects the
level of innovation for each research team. Table 4
shows a ranking by research team for the landscape
of this medical device. Clearly Pfizer, the University
of California, Wythe, and Eli Lilly have high values
of IMmax. Taken together, their patent activity levels
in this technology space and their high IMmax values suggest that, of all the major companies in the
landscape, these assignees are conducting the most
focused research into the technical area. The data
on patent issued per patent application can imply
research focus.
Top Innovators
Innovation metrics also help to identify companies
that are making fundamental contributions to the
technology or are integrating multiple concepts into
a single solution. Experience with this data set has
Table 4. High R&D Investment Companies
Documents
Patent
Applications
Pfizer
427
320
107
33%
12
NeuroSearch
274
217
57
26%
8
Astrazeneca
219
191
28
15%
6
Abbott Laboratories
164
154
10
6%
4
153
136
17
13%
15
Merck
138
119
19
16%
8
Wyeth
119
109
10
9%
10
Medtronic
116
79
37
47%
8
Vertex Pharmaceuticals
113
83
30
36%
5
Bristol-Myers-Squibb
112
92
20
22%
5
LaRoche
102
74
28
38%
4
University of Texas
100
83
17
20%
4
Janssen Pharmaceutical
100
91
9
10%
5
Eli Lilly
100
74
26
35%
12
85
61
23
38%
4
Novartis
Patents
Issued
Patents/
Application
Innovation
Metric
March 2014
21
Table 5. High IMmax Assignees
Assignee
Title
IMmax
Total
IMmax > 5
GlaxoSmithKline
Conserved yeast nucleic acid sequences
40
37
3
1995
Betagene
Recombinant cell lines for drug screening
30
5
5
1999
Betagene
Compositions and methods for regulated
secretion
24
5
5
1999
Astrazeneca
Potassium channel subunit
24
229
4
1999
Autogen Research;
Deakin University
Therapeutic molecules
24
2
2
2004
Primal
G Protein coupled receptors
21
1
1
2003
Nura
Nuclear receptor-based diagnostic,
therapeutic, and screening methods
21
1
1
2003
Meditech Research
Modulation of hyaluronan synthesis
18
2
2
2004
Chemgenex
Pharmaceuticals
Differential expression of nucleic
acid molecules
18
1
1
2003
Agt Biosciences
A gene and uses therefor
18
1
1
2004
Cortex Pharmaceuticals;
Georgia Tech
Use of calpain inhibitors
16
22
1
1991
Genostic Pharma
Probes used for genetic filing
15
3
2
1999
NeuroPace
Systems, methods and devices for skull/
brain interface
15
31
4
2008
Shapiro, Howard K.
Pharmaceutical compositions and
use thereof for treatment of
neurological diseases
15
7
3
1994
Method of alleviating neuropathic pain
15
153
8
1997
shown that documents with IMmax of five or more
are most likely to be targeting the intended technology landscape. Consequently, filtering by IMmax>5
was used to identify research teams that are at the
forefront of innovation within this technology space.
This is a highly useful method for reducing the effects
of portfolio size on the evaluations while eliminating
incrementally narrow innovations.
Table 5 shows a large number of assignees with
relatively few total documents, in contrast to Table 4,
which primarily identified large companies. However,
the fact is that significant innovations in the life sciences are often done by individual inventors or small
companies. Also note that, while the University of
California had a high degree of R&D investment (153
documents altogether), only a small percentage of the
investment actually targets the technology of interest
(8 documents with IMmax > 5).
Company Dashboards
Company dashboards provide a historical and cu22
les Nouvelles
Documents
Year
mulative view of a company’s activity. Because they
are document count-based, they are reflective of
how a company views itself within the competitive
environment.
The company dashboard (Table 6) illustrates the
high activity areas for which the company has a
competitive advantage. Patterns can be observed
to assess their strategic focus and efforts. In the
example presented, the company uses Perfected Analytes (1-3) in a variety of disorders such as Epilepsy,
Neuro-Degenerative Diseases, Neurostimulation,
Acute CNS Diagnostics, and Brain Neuro-Sensors
(B, D-G). A pattern of peak followed by declining
effort can also be seen with CNS Pattern 1 (6) and
Device Channels (9). Filing activity and IM values
suggest that the majority of the associated research
was conducted 2001-2006. The declining metrics
suggest that they either achieved the solutions they
were looking for or have redirected their research.
Reviews of the actual patent document both during
Table 6. An Example Of Company Patent Activity
Analytes
Disease
1
Metabolism Patterns
2
3
4
5
6
Probe
7
8
9
10
11
A
B
C
D
E
F
G
H
I
J
Disease and attribute key: emergent = white, pacing = light blue, mature = blue.
Landscape activity key: no activity = white; 1 to 4 = dots; 5 to 7 = slanting lines; 8 to 20 = cross-hatching.
and after the innovation period might lead to better
insights regarding the cause of the declining activity.
Figure 4 shows the document filings and the IM’s by
year for the company in this technology space.
Conclusions
s
l
s
s
ls
s
ss
l
s l s
s
s ls
Year
2005
2000
s
1995
20
l
l
l l
s
2015
s
s
2010
5
1990
Number of Documents or Maximum IM
for different technology landscapes. Developing
the Hierarchy of Invention sketch led to improved
definition and understanding of the landscape. In
particular, it helped the team identify and integrate
all the device elements needed for commercial
Outcomes for the Academic Research Team
systems and what the scale-up issues might be. The
This patent technology landscape process had
identification of new markets has led the team to see
a number of tangible benefits for the academic
new directions and priorities for future research and
research team. For this device, a two dimensional
development projects. While the academic research
visualization of the landscape (the attribute-market
team could not perform the sophisticated searches
matrix) was an effective tool for understanding the
(such as were conducted by the consultants) on its
potential commercialization opportunities for the
own, it might do simple, ad hoc searches for initial
device IP. Other visualization tools might be used
assessment of new markets in the future. At
its current stage, the academic research team
Figure 4: High Innovation Metrics Over Time: is actively pursuing partners for collaborations
An Example Company
leading to clinical trials. Company dashboards
have been particularly useful to the team as
20
l
it considers how best to match its technology
l documents
to the commercial environment. In summary,
l
the academic research team has already begun
15
l
s max IM
to internalize this patent technology landscape
l
process as a vital part of the process of moving
l
10
IP from lab to marketplace.
l
Using a patent technology landscape process
on a new technology case study resulted in the
following benefits:
• New markets were identified, with possible
shorter commercialization pathways and generation of revenue streams that could support
further expansion of the technology;
March 2014
23
• Device attributes were clearly defined;
• Small business collaborators with high innovation potential were uncovered; and
• The strategies of large corporations in the current technology space were characterized.
Overall, the interoperative chemical diagnostics
device appears to have broad applicability in market
areas that have significant needs but low competition
currently. The process is flexible and allows for analysis of complex patent technology landscapes. This
patent technology landscape process has applicability
in both industry and academic environments where
teams are seeking a “higher-level” and unbiased view
of their technology. The authors see tremendous potential for cross-functional academic teams to exploit
this approach in order to identify opportunities for
collaboration that can monetize their innovations to
meet market needs. ■
Acknowledgements
The project described was supported by the National Center for Advancing Translational Sciences,
UL1TR000117, and the National Center for Advancing Translational Sciences, UL1TR000117. The
content is solely the responsibility of the authors
and does not necessarily represent the official views
of the NIH.
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Venture Capital 101
Jargon, Term Sheets, And Documents
A Primer for Academic Technology Transfer Managers and
Industry Licensing Executives
By Louis P. Berneman and Christopher F. Wright
selves dealing with financing and other new venture
business development issues. Technology managers
ith the heightened attention of senior
and industry licensing executives now need to unacademic administrators to promoting
derstand the mentality
economic development and fostering inof venture capitalists and
■ Louis P. Berneman,
novation ecosystems, academic technology transfer
other
institutional
invesOsage University Partners,
organizations are increasingly focusing their comtors
and
become
fluent
Founding Partner,
mercialization activities on identifying, qualifying,
with
their
jargon,
term
Bala Cynwyd, PA
incubating, accelerating, and financing start-up vensheets,
and
documents.
E-mail: lberneman@
tures. This top down pressure is aligned with bottom
This
article
seeks
to
demysosagepartners.com
up pressure from faculty researchers who, albeit for
tify
venture
capital
(“VC”)
different reasons, are likewise increasingly interested
■ Christopher F. Wright,
start-up dealmaking.
in the impact of their discoveries and seeking to
Esquire,
Background
commercialize them through start-ups. Moreover,
McCausland Keen & Buckman,
technology managers are now thrust into new roles,
Not-for-profit research
Shareholder,
such as creating pre-license value, recruiting investinstitutions continue to
Radnor, PA
able management, raising capital, and positioning
be epicenters of innovaE-mail: cwright@
licensed technology to become part of a commercially
mkbattorneys.com
tions as envisioned in the
successful product in a thriving company. Likewise,
virtuous cycle of technolfor a variety of reasons, industry licensing executives
ogy transfer and commercialization in 1945 by Vanare increasingly out-licensing de-prioritized corporate
nevar Bush in Science, the Endless Horizon.1 While
R&D projects to start-up ventures. Like their academic
the U.S. corporate research spend has been volatile,
counterparts, industry licensing executives find themand even decreasing, federal funding for basic research in academe
has grown steadily
Figure 1. Epicenters Of Innovation
and significantly. See
Figure 1.
Basic and Applied Research—Universities vs. Industry ($B)
University start-ups
80
Industry Research Spend
are the epitome of
U.S. corporate research spend is
70
volatile and in some sectors
Bush’s virtuous cycle
reducing significantly
vision as approxi60
University Research Spend
mately 75 percent of
Universities are an increasingly
50
them locate within 50
reliant and consistent source for
miles of their discovresearch
and
discovery
40
ery source.2 Univer-
Introduction
W
30
20
10
Industry Research $
University Research $
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Innovation Epicenter
Universities are increasingly
becoming centers for innovative
start-ups—75% of start-ups are
within 50 miles of their
discovery institution
1. Vannevar Bush, Science, the Endless Horizon, 1945.
2. FY2011 AUTM U.S.
Licensing Activity Survey,
Table 12: Startups Formed
and Primary Place of Business, 2007-2011.
March 2014
25
Venture Capital 101
Figure 2. Focus On Entrepreneurship At Universities
University Start-Ups Formed
700
651
671
650
700
CAGR = 7.1%
(’94–’11)
600
595
600
553
500
596
555
550
400
500
300
2006 2007 2008
2009 2010
2011
200
100
0
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
Number of Start-Ups Formed
800
TOP DOWN and BOTTOM UP Pressures
STRONG GROWTH AHEAD
Top down pressure from administrations
to foster entrepreneurship
University start-up activity at an all
time high with 670 new start-ups formed
in 2011—the growth in entrepreneurship
activity at universities remains strong
Bottom up pressure from researchers that
want their work to be impactful
sity start-up activity is at an all time high with 670
new ventures formed in FY2011.3 See Figure 2.
Technology managers (“TMs”) at academic institutions, including teaching hospitals and non-profit
research institutions, have become increasingly adept
at all aspects of the technology transfer and commercialization process:
• Creating an innovation ecosystem;
• Establishing and maintaining positive and productive relationships with faculty,
administrators, and civic leaders involved in
the innovation ecosystem;
• Ferreting research discoveries addressing
unmet needs and possessing commercial
potential;
• Assessing technology disclosures and business development opportunities (triage) for techni-
cal merit, commercial potential, protectability, and inventor profile;
• Working with outside counsel to prepare, file, prosecute, maintain, and enforce patents and patent applications;
• Marketing licensing opportunities;
3. Ibid.
26
University Start-Ups Formed
Between ’06-’11
les Nouvelles
• Negotiating term sheets and license agreements;
• Creating and managing various types of
innovation funds (proof-of-concept, seed,
and growth);
• Selecting, developing, and launching start-up ventures and establishing and maintaining
relationships with institutional investors;
• Managing equity in start-ups; and
• Maintaining relationships and license
agreements with licensees.
While these efforts are beneficial, it is also true
that success in academic technology transfer is often
a function of world-class investigators with substantial
research funding working cooperatively with their
industry counterparts and venture investors. Furthermore, successful academic technology transfer is
also a function of diligence, perseverance, patience
(managerial longevity and continuity), an enlightened
administration, and luck.
TMs “know” but find it difficult if not impossible
to act on what they know about launching successful
start-ups. Research confirms what experienced startup business development (“SUBD”) TMs know—academic start-ups managed by industry experienced
entrepreneurs who secure venture capital funding
are more likely to be successful than companies led
Venture Capital 101
by faculty and graduate students moonlighting as
entrepreneurs and capitalized solely with funds from
friends and family, angel, and research grants.4 The
study notes that respondents confirm that venture
capitalists are not only important sources of funding,
but that they also provide mentoring and networking
services and technical expertise important to start
-ups and that faculty with industry consulting and
prior entrepreneurial and industrial experience better
understand markets and technology development.
Venture Capital Mentality
TMs’ and industry licensing executives’ SUBD
knowledge, skills, and attitudes have progressed
substantially in recent years. Increasingly, technology
licensing offices (“TLOs”) are employing individuals in
SUBD functions who have training in venture capital.
However, experience indicates that TMs without such
experience have, at best, only a modest understanding
of venture capital. Much of the same can be said about
industry licensing executives, albeit their typical
backgrounds (commercial, technical, and/or legal) and
work experiences may provide a more relevant base.
As a first principle, venture capitalists (“VCs”) seek
to finance potentially transformative companies based
on a disruptive (platform) technology (secret sauce)
represented by a lead materially differentiated product
in a substantial market that addresses a compelling
unmet need. Ideally, the company is led by industry
experienced chief executive officer (“CEO”) and
management team. Indeed, all of these are essential
elements–secret sauce, market opportunity, product
differentiation, and management5– are required.
However, even these essentials elements may not
be sufficient to generate a “yes,” positive investment decision. It is far easier, less risky, and human
resource conserving for a venture capitalist to say
‘no,’ to ‘pass’ and not do a deal, than to invest in
one. In fact, venture investors consider hundreds of
4. New York Academy of Sciences, “Predicting Spinoff Success,”
http://www.nyas.org/Publications/Detail.aspx?cid=d534df1d-ae314bb9-bf27-e51c5c1c4720.
5. While industry experienced management is essential for
later stage companies seeking financing, discovery stage ventures
may be fundable without an investable CEO. VCs, especially
those willing to do “complete assembly” start-ups are more likely
than not to have relationships with executives who may be “in
residence” or otherwise affiliated and are able to serve as interim
CEOs. This level of management leadership may be all that is required for early stage technologies funded to establish proof-ofprinciple and confirm the founding scientific hypothesis of the
venture. Institutions and companies seeking funding are advised
to position and title management personnel without requisite
CEO level capability as “interim,” “general manager,” or other
designation signaling temporary status.
opportunities, many with superior technology and
commercial potential and with all of the essential
elements enumerated above, for each deal in which
they do make an investment.
Further, VCs often exhibit lemming-like behavior—
they tend to follow the crowd.6 Discovery institutions
and organizations are advised to monitor investment
behavior as sector tailwinds and headwinds change
frequently.
While investment sectors have come in and out of
favor, venture fund performance during the past two
decades has been a roller coaster. 1999-2003 vintage
funds have produced poor returns. More recent
funds have produced healthier returns. As a result,
both the number of funds and the size of funds have
contracted (some observers would say they have been
‘right sized’). See Figure 3.
The Essential Elements
Management is Paramount
Recognizing the earlier caveat about prospects for
obtaining institutional financing in the absence of
industry experienced management for early/discovery
stage technologies, management is essential in generating a positive investment decision, especially for
later stage opportunities. Analogous to real estate’s
mantra of “location, location, location,” in venture
capital, the slogan is “management, management,
management”! So, what constitutes investable
management? Experience indicates that complete
assembly investable CEOs possess a variety of characteristics and that there is no unique, prescriptive
description. However, the following characteristics
are evident in most successful CEOs of venture
backed start-ups:
• Ideally, the CEO is already known to potential institutional investors and has made money for investors in the past or has been referred by a trustworthy colleague or friend and has a track record of effectively managing finances
to a successful exit for investors;
6. In 2013, for example, as a group, VCs are more interested
in early stage information technology (“IT”) given the capital
efficiency and potentially significant valuation step up from
seed to Series A. In particular, there are also strong tailwinds
(positive investment climate) in 2013 for healthcare IT opportunities. While there appears to be much ‘talk’ about interest
in ag-bio, few venture investments are being made in this sector. Conversely, strong investment headwinds are being felt in
capital intensive sectors including clean energy and electronics.
Therapeutics, the mainstay of academic discoveries and biopharmaceutical company spin-outs, continue to generate interest, despite their capital intensity, especially in oncology and
orphan indications.
March 2014
27
Venture Capital 101
Figure 3. Venture Fund Performance
Vintage Year
Median (%)
Upper Quartile (%)
1990
21.54
31.19
1991
17.61
27.59
1992
20.99
38.85
1993
18.83
46.49
1994
26.45
46.45
1995
41.65
80.62
1996
40.87
83.33
1997
9.65
63.34
1998
(0.58)
15.19
1999
(3.43)
2.99
2000
(2.34)
3.99
2001
(0.41)
6.29
2002
1.22
7.80
2003
0.08
7.35
2004
1.11
7.19
2005
2.08
9.08
2006
4.54
9.28
2007
8.13
20.12
2008
6.27
16.83
• An investable CEO is able to tell “the story” effectively, that is, able to share a vision of
the company in an interesting and compelling manner;
• Fundable entrepreneurial CEOs also exhibit certain personal characteristics including,
intelligence, persistence, resilience, self awareness, open-mindedness, the ability to learn, and a manageable ego;
• Investable CEOs have a relevant commercial background and experience; they understand the market and what customers need, want,
and are willing to buy; in positioning the com-
pany, the CEO shares data indicating why cus-
tomers will be interested in the product/
service and speak authoritatively about the 7. Market knowledge and understanding is also what investors want to see and hear from TMs pitching technology transfer
deals. In fact, investors often say that this lack of real world
relevant industry experience is what they would most want to
change in both TLOs and TMs.
8. Conversely, investable CEOs do not try to sell a ‘field
of dreams;’ that is, if the company builds it, customers will
surely come.
28
les Nouvelles
Poor Returns
Too Many Funds
Inexperienced Investors
Herd Behavior
Hype Bubble Burst
Healthier Returns
Fewer Funds
Experienced Investors
Flight to Quality
market from personal experience.7, 8
Experienced business development executives
understand the imperative of an investable CEO and
management team. But, management teams with different backgrounds and skills are required at different
stages of the life cycle of venture-backed companies.
Many science-driven and science-focused discovery, seed, and early stage ventures may not need a
full-time industry-experienced CEO. Rather, these
nascent companies may need a great chief scientific
officer and business development or chief business
officer. Anointing either the chief scientific or business development officer as the future CEO can create organizational challenges downstream. Keeping
the CEO role intentionally vacant and allowing the
investing VCs to recruit the CEO can minimize future
organizational disruption.
If the secret sauce (technology, platform, product,
IP) in the deal is the horse, then the CEO is the jockey.
VCs bet on jockeys riding horses with great pedigrees
and huge potential. Even the most interesting opportunity (i.e. horse), without an able CEO (jockey) is
not likely to be investable (unless the investor is able
and willing to change management at the outset or
Venture Capital 101
near-term) if the team fails to perform as predicted.
As part of the management consideration component of an investment decision for a science-driven
venture, investors are also concerned with the role
founding scientists will play in the new company and
whether their incentives and rewards are aligned with
investors. Investors are also concerned that founding
scientists serving in management and fiduciary roles
may be too focused on proving the technology, rather
than finding the market and developing products and
customers. Investors want founding scientists to ‘let
go’ and defer decisions related to development of the
technology to commercially-oriented decision makers.
Most venture investors would prefer that founding
scientists remain in their academic positions and help
the company as members of scientific advisory boards,
rather than in R&D operations or other managerial or
fiduciary roles.
For many academic start-ups, too often, the question is what to do with a potentially great project
without an investable CEO? As stated earlier, business
development licensing executives seeking financing
for a start-up without an investable CEO are advised to
acknowledge the shortcoming and express interest in
recruiting management from the investor’s network.
Identifying and recruiting investable management,
even for the most worthy projects, is a daunting,
perhaps the greatest, challenge confronting TLOs.
Industry business development executives may have
some advantages in this regard; however, entrepreneurial experience and mentality may not be the
characteristics of big company managers.
A number of institutions have experimented with
a variety of mentor, entrepreneur-in-residence, and
related programs. These programs vary in nature
and include both formal and informal activities.
For example, the University of Michigan TLO, uses
mentors-in-residence, a internally-managed gap fund,
a catalyst talent network, and a variety of events to
identify and recruit CEOs.
• Mentors-in-Residence program embeds
seasoned entrepreneurs in 3-8 start-up
projects, guiding them from initial evaluation
through business modeling, launch and
support. They can bridge as interim manage-
ment, but more often use their networks to help
find fundable management. See http://www.
techtransfer.umich.edu/resources/venturecen
ter/mentors.php.
• Gap Fund Program uses internal funds,
matched by a generous state program, to
fund commercial readiness activities to
address and resolve known risks and engage
by contract potential CEOs in transition. See http://www.techtransfer.umich.edu/resources/
venturecenter/gapfunding.php.
• Catalyst Talent Network is a database of
talent, (experts, volunteers, consultants,
potential CEOs managed by a Talent Manager staff member to match needs. See http://
www.techtransfer.umich.edu/resources/
venturecenter/catalyst.php.
• Events are used to attract, engage and
motivate talent to work with projects and
start-ups, leading the execution of certain strategic events and partnering with
others. See http://www.techtransfer.umich.
edu/resources/venturecenter/net
working_events.php.9
Secret Sauce, Market Opportunity, and
Product Differentiation
In many technology sectors, an investable start-up
consists of a proprietary, disruptive, paradigm shifting, breakthrough technology platform. The science
is protected by patents which are expected to provide
both freedom to operate and the ability to exclude
others. The platform technology is exemplified in a
differentiated (better) lead product that resolves an
unmet need in a compelling market opportunity. The
platform aspect of the technology is important in that
it provides for additional product opportunities given
the high failure rate and attrition in R&D projects.
Platform technologies provide a degree of investment
security, especially in capital intensive R&D sectors.
Platform technologies also permit companies to enter
into multiple strategic collaboration and business
relationships which provide sources for non-dilutive
R&D funding.
Ideally, the breakthrough technology platform
and lead product have been published (after patent
filing) in a leading journal authored by a key opinion
leader. “The peer review process of a highly selective and competitive journal validates that the idea
may be a significant breakthrough.”10 Data supporting the patent application optimally demonstrates
proof-of-principle, technical merit, and commercial
potential. In addition, other key opinion leaders have
endorsed the scientific foundation of the venture
and have published data replicating and confirming
the original observation.
9. Thank you to Ken Nisbet, Executive Director of the University of Michigan TLO, for his assistance in crafting this section regarding identifying and recruiting investment CEOs.
10. Robert Langer, Nature Biotechnology 31, 487-489 (2013).
March 2014
29
Venture Capital 101
In presenting the investment opportunity to potential investors, business development executives and
entrepreneurs are advised to describe the company
and investment opportunity in a non-confidential
2-3 page narrative (executive summary) or a concise
slide presentation. The description should include
the scientific foundation and data indicating proofof-principle, technical merit, and potential commercial relevance. Investors recognize that academic
discoveries and investment opportunities will have
a paucity of data validating the scientific foundation
of the discovery and venture.
Business development executives are advised to
establish and maintain relationships with investors
with aligned strategic interests. Venture capital is
a relationship-based industry. Getting an audience
with a VC is much easier if there is an established
relationship. VCs have historically kept abreast of
scientific advancements through journals and conferences and welcome opportunities to interact with key
opinion leaders in areas of interest. With the recent
contraction of the VC industry, however, funds have
fewer resources devoted to sourcing, thus making
outreach and relationship building activities even
more important.
O.K.! Your Start-up has a Meeting Scheduled
With a VC; Now What? What Can You do
to Help?
Congratulations! If your start-up has been invited
to meet with a potential institutional investor, the
venture has already cleared a huge hurdle. Upon
initial review or referral, your start-up has been seen
as sufficiently interesting to warrant investors’ time
and consideration.11 Different investors approach
initial meetings differently, and entrepreneurs and
business development licensing executives making
pitches should inquire as to how investors prefer to
approach these initial meetings. Some investors may
want to be ‘pitched,’ that is, for someone to make a
(brief) presentation about the essential elements of
the business—management, secret sauce, market
opportunity, and product differentiation. However,
many VCs will not want to be pitched, listen to a
presentation, or even review a slide deck. It is more
likely than not that an experienced investor will have
prepared for the meeting having thoroughly studied
the slide deck and related material, and perhaps
even having done preliminary due diligence on the
opportunity. Presenters should be prepared to engage
11. Experience indicates that other than meetings taken as a
courtesy, VCs meet with only about 10 percent of pitched deals.
30
les Nouvelles
in a discussion of their vision and how they intend to
develop the technology and the company and their
understanding of the market and customers’ needs.
TLOs are increasingly launching programs to
assist budding academic entrepreneurs to obtain
non-dilutive capital in the form of grants to de-risk
investment opportunities, e.g., SBIR grants. Funds
from such programs can be used successfully if capital
is used to conduct the “right” experiments and gather
data indicating the technical merit and commercial
potential and relevance of the scientific hypothesis.
However, without industry experienced guidance,
academics rarely possess the commercial expertise
and resources necessary to identify and conduct
the needed gating, de-risking experiments. Business
development executives are advised to obtain industry guidance in the identification, selection, design,
conduct, and reporting of de-risking experiments.
Finally, business development executives are advised
to communicate effectively and in a timely manner
with investors expressing interest in an opportunity.
While VCs may take months, or even years, to reach a
positive investment decision; once they do, they want
to act quickly to conclude agreements in a timely and
frictionless manner. VCs have little patience for what
they view as unnecessary delays, untimely communication, and non-standard license terms.
VC Financing Jargon, Term Sheet,
and Documents
As stated previously, the purpose of this article is
to demystify venture capital financing jargon, term
sheets, and documents. Venture Capital financing
jargon is not in the common lexicon of business
development and licensing executives.12 VC term
sheets and documents focus on an equity financing
round with a company and do not resemble license
term sheets and agreements.13
The VC financing term sheet is the basis for and
summary of the material economic terms, that is the
terms that matter, to VCs. Typically, a lead investor
proposes a financing term sheet to a company upon
completion of its due diligence and decision to make
an investment. A summary of the material terms of
12. For a more extensive discussion of term sheets, see Berneman, L.P., Denis, K.A. and Wright, C.F. “Using Term Sheets
to Get What You Need and Negotiate for What You Want in
Industry-University Licenses,” in Association of University Technology Managers Technology Transfer Practice Manual, Marjorie
Forster, editor. 2003.
13. See Exhibits A and B to compare and contrast a model
license term sheet and VC financing term sheet. [ADD: cross
reference to NVCA forms on web].
Venture Capital 101
the proposed financing, term sheet, is typically presented in a form of letter or other agreement signed
by the lead investor(s). The term sheet, more often
than not, includes a summary of the transaction,
investors’ rights, and other provisions. The proposed
financing term sheet will eventually be documented in
a series of comprehensive related agreements, which
generally include:
• Certificate (Articles) of Incorporation of the company, also often referred as the
company’s charter (“Charter”);
• Stock Purchase Agreement (“SPA”);
• Investor (Shareholder) Rights Agreement (“IRA”);
• Right of First Refusal/Co-Sale Agreement; and
• Voting Agreement.
Venture capital financing term sheets are generally
not binding upon the parties, except for a ‘no shop’
period of exclusivity and confidentiality provisions,
which are binding.
The deal summary (often, the cover sheet of the
Term Sheet) identifies the company, the investors
and the amounts each is committing, the class of
stock to be issued (e.g., Series A Preferred), and the
principal terms of the financing. These principal terms
generally include amount of the financing (including
tranches, where appropriate), price per share, premoney valuation, financing closing schedule, use of
proceeds, and equity capitalization (cap table).
The Certificate (Articles) of Incorporation/
Charter is the key document in a VC financing. The
Charter defines and references the terms that convey the economics of the transaction. The Charter
presents the complex issues in a financing. Charters
are neither easily read nor understood, even by experienced investors, entrepreneurs, and their counsel.
The key terms in the Charter, as in the financing term
sheet, described in greater detail below, include the
class of equity being purchased (e.g., participating
preferred), dividends, corporate controls, liquidation
preference, voting rights, anti-dilution, mandatory
conversion, and pay-to-play.
The Stock Purchase Agreement (“SPA”) sets
forth the basic terms of the purchase and sale of the
security (e.g. preferred stock) including the purchase
price, closing date, and conditions to closing. Generally, the SPA describes neither the characteristics of
the stock being sold (which are defined in the Charter) nor the relationship and agreement among the
parties related to the stock after the closing, such as
registration rights, rights of first refusal and co-sale,
and voting arrangements. Major terms of negotiation
in the SPA include:
• The price and number of shares being sold
and the use of proceeds;
• Representations and warranties that the
Company (and often the Founders) make to
the investors and vice versa;
• The company’s and investors’ obligations
(conditions) at closing; and
• Other provisions likely to include requiring
the Company to reimburse ‘reasonable’
expenses of the investors and their counsel related to the financing.
The Investor Rights Agreement (“IRA”) typically
covers a variety of issues, including:
• Investors’ rights related to registration of
their shares for public offerings;
• Management and information rights;
• Right to participate pro rata in future
stock issuances;
• Matters requiring approval by the Board;
• Non-competition and non-solicitation
agreements;
• Board matters;
• Employee stock options;
• Key person insurance; and
• Related covenants and other provisions
intended to protect investors’ interests.
Right of First Refusal / Co-Sale Agreement, also
referred to as “take me along right,” enables the company first and investors second a right of first refusal
to purchase shares offered for sale by founders and
gives the investors the right to sell a portion of their
shares as part of any sale of shares by the founders.
Voting Agreement describes the composition of
a new Board of Directors upon closing the financing
on any voting restrictions on shares.
Negotiating the Financing
VC financing term sheets are investor-centric. That
is, the document and its terms represent the needs
and wants of investors and deal terms that matter
to them. Like good license term sheets, which seek
to create a win-win risk-reward balance, venture
capital financing term sheets, while expressing the
interests of investors, serve as a first offer or floor
for negotiations.
As in all negotiations, leverage matters, as do negotiating skills. Negotiating leverage and skills are
impacted by the circumstances of the negotiation,
situation of the parties, and each party’s ability to
effectively utilize their knowledge and power. LeverMarch 2014
31
Venture Capital 101
age is key, as is the Golden Rule (he/she with the
gold, makes the rules).14
VCs from different regions (e.g., West Coast and
East Coast) and technology sectors (e.g., life sciences
and technology) differ in needs, wants, and customary practices in financings. However, the jargon,
term sheets, and documents are consistent across
geographies and technology sectors.
Equity Stakes
Institutional and organizational founders, as licensors, typically take common stock as founders (as
opposed to preferred stock which is taken by cash
investors). Equity is typically taken in lieu of up front
licensing fees. However, the amount of common stock
taken varies greatly among different institutions and
technology sectors.
Generally, founders take equity at the time of a
company’s founding, and the amount and value of
equity is typically included in the pre-money value
of the company. Experience indicates that founders
equity pre-money value is typically in the $2M to
$7M range. These pre-money values directionally
represent fully diluted ownership interest in the
range of 2-40 percent. Institutions’ founding equity
14. Golden Rule, of course, also is true for future financings. Anytime a new investor with leverage, enters the picture
everything agreed to by previous investors and the company is
subject to re-negotiation and change.
15. Equity models other than up front exit, including milestone and phantom equity. Though no longer common, historically some institutions deferred taking up front equity positions
in favor of being granted equity positions based on the achievement of pre-determined corporate and product development
milestones or benchmarks. The equity given at the milestone
is based upon the fully diluted share count at the time of the
milestone achievement. For example, a university might receive
0.375 percent equity in the company at the time of IND filing and an additional 0.75 percent upon finishing Phase 2 studies. Among the challenges with the milestone equity model for
universities is that they only receive equity at predetermined
milestone events, which may not be achieved prior to an exit.
More common than milestone equity structures, but now
also generally out of favor except in “express licenses” and the
like, is phantom equity. Clearly, phantom equity is gaining in
popularity as express license structures are used. Phantom equity is an arrangement in which the institutional founder does
not hold equity in a start-up until the time of the company’s
sale (exit). In this equity structure, the founder is given an
amount of cash equal to a pre-determined percentage of the
market value of the enterprise at the time of sale. For example,
as part of their “Carolina Express License,” the University of
North Carolina takes 0.75 percent of the start-up’s fair market
value at the time of a liquidation event (M&A, IPO, asset sale).
The NIH is currently using a similar structure and UCSF used
a similar structure in the past. Typical phantom equity is in the
range from 0.5-2 percent market capitalization (value) at exit.
32
les Nouvelles
position, as opposed to the inventors’ stake, is typically a contentious point of negotiation. Experience
indicates that investors perceive the institutions’
contribution in historical terms and as relatively little
importance. Conversely, investors often view inventors’ contribution, retrospectively and prospectively,
as more valuable.15
Experience indicates that the variance in pre-money
value and founders’ equity (institutional and inventors) is multi-factorial based on:
• Technology sector;
• Market opportunity;
• Stage of development of the technology and product;
• Perceived value of pre-license value creation (sweat equity);
• Scientific founders’ experience and track
record in commercialization, generally, and
start-ups, specifically;
• Institution’s experience, ability, and track
record (reputation) in launching start-ups that create value for investors;
• Potential exit value and risk; and
• Nature and scope of licensed patent rights.
Understanding these value drivers and VC financing
mentality, jargon, term sheets, and documents is critical for those seeking to be taken seriously by VCs and
to realize value from their successful start-ups. However, and especially for start-ups in capital-intensive
sectors (e.g., therapeutics, devices, diagnostics, clean
tech, etc.), equity dilution is significant resulting in
a financially immaterial percentage of ownership.16
Increasingly, institutions are including in their
license and stock purchase agreements the right for
them and their assignees to invest in future financing rounds. This right is called a Participation Right
or Pre-emptive Right. Typically, other investors enjoy
this right to participate in future financing rounds and
thereby avoid unwanted dilution.
Equity dilution, especially in capital intensive
ventures, substantially reduces the opportunity for
material financial gain from equity at exit. A Participation Rights enables the institution, and/or an affiliated
fund, to invest dollars alongside other investors in
future rounds. Business development executives are
16. A study by Berneman et. al. at U Penn in 1999 found that
across multiple institutions and technology sectors, the average
equity percentage holding for institutions at the time of exit
was 0.6 percent.
Venture Capital 101
encouraged to insert Participation Rights language in
their license agreements to preserve the right.
Participation Rights Language
If the Company proposes to sell any equity securities
or securities that are convertible into equity securities of the Company, then the University and/or its
Assignee (as defined below) will have the right to
purchase up to 10 percent of the securities issued in
each offering on the same terms and conditions as are
offered to the other purchasers in each such financing.
Company shall provide thirty days advanced written
notice of each such financing, including reasonable
detail regarding the terms and purchasers in the financing. The term “Assignee” means (a) any entity to
which the University’s participation rights under this
section have been assigned either by the University or
another entity, or (b) any entity that is controlled by the
University. This paragraph shall survive the termination
of this agreement.
Key Terms in Venture Capital
Financing Documents17
Charter
The Charter is a document publicly filed with the
Secretary of State of the state in which the company
is incorporated. The Charter establishes the rights,
preferences, privileges, and restrictions of the security (stock) itself.18 The Charter is the only meaningful
document that is publicly filed. Delaware is considered a company-friendly state and, thus, Delaware is
often the preferred governing forum for companies
seeking or likely to seek institutional financing. As
stated earlier, the Charter contains the deals terms
that affect the economics of the transaction to the
investors.
Liquid Preference/Participating Preferred
First and foremost among the terms in the Charter
is the nature and class of the security (stock) itself,
e.g., preferred, and whether and to the extent the
class of stock has a liquidation preference or participates, e.g., participating preferred with the common
equity holders. Liquidation preference refers to the
multiple on its initial investment that investors are
entitled to receive from capital paid by an acquirer
prior to conversion of the investors’ preferred stock
to common stock. In effect, this is a bonus payment
17. Readers may wish to view model financing documents
from the National Venture Capital Association. See http://www.
nvca.org/index.php?option=com_content&view=article&id=10
8&Itemid=136.
18. Model NVCA Term Sheet, March 2011.
to investors, presumably for the risk. Investors use
liquidating preference / participation to adjust the
economics of the financing, that is their return
potential and risk, based on pre-money valuation.
Participating preferred is more commonly found in
life science transactions than those in the technology sector.
• A full participating preferred entitles the
investor to receive a multiple of its invest-
ment as a payment prior to conversion to
common.
• A partial participating preferred entitles
the investor to receive that portion (e.g.,
half) its investment prior to conversion to
common.
• A liquidation preference may also be capped
its total dollar return to investors.
Investors refer to calculations computing the effect
of the liquidation preference as the “waterfall.” The
waterfall is a financial model to express the potential
returns to the investor based upon the eventual exit
value of the company. The waterfall calculates returns
for investors of different classes of stock based on
their rights and preferences.
Dividend
The dividend specifies the minimum return on
investment as a percentage of capital invested. An
8 percent return is typical currently. Dividends may
be accrued and cumulative. Unpaid dividends may
be paid upon conversion of the preferred stock to
common stock prior to a liquidation event. Typically,
dividends are not paid if the preferred is converted.
Alternatively, the company may have the option to pay
accrued and unpaid dividends in cash or in common
shares valued at fair market value, which is referred
to as payment-in-kind (“PIK”) dividends.
In effect, dividends are a financial ‘kicker’ to investors above and beyond equity appreciation. For
example, a $10 million preferred stock investment
is entitled to receive upon a liquidation event (exit,
acquisition) a dividend (or coupon) equal to 8 percent
on $10 M accrued and compounded daily from the
date of investment until liquidation.
Voting Rights
Typically, preferred stockholders are entitled to vote
their shares together with common shareholders as a
single voting class. The Charter may also contain veto
rights in favor of the investors. The Charter sets out
the number of authorized shares and the number of
members of the Board (Directors) preferred shareholders are entitled to elect.
March 2014
33
Venture Capital 101
Anti-Dilution Provisions
Preferred investors often seek protection in the
event that the company issues additional securities
at a purchase price less than the conversion price
on the shares purchased by the preferred investors.
Anti-dilution provisions detail the adjustment to the
conversion price to protect the existing preferred
shareholders from dilution. Two conversion methods
are typical—weighted average and full-ratchet. The
weighted average method considers the number of
new shares to be issued relative to the number of
shares already outstanding. The full-ratchet method
is less frequently used and reduces the conversion
price of the previously purchased preferred shares
to the price at which the new shares will be issued.
Mandatory Conversion
Preferred shares are automatically converted to
common stock upon an underwritten initial public
offering (“IPO”) of an acceptable size. Investment
bankers generally require this mandatory conversion.
Exceptions to mandatory conversion are used to preclude a single investor from controlling the timing of
the conversion.
Pay-to-Play
This recently adopted provision is becoming more
typical. In effect, pay-to-play penalizes existing investors for declining to participate, on a pro-rata basis, in
future/follow-on rounds of financing. This provision is
desired by new investors who want existing investors
to support a new round. This provision is increasingly
common in bridge rounds and deals in which there
are angel investors. (It has been suggested that the
provision disproportionately penalizes angels, which
may be the intent of VCs.) This provision seems to
be invoked more commonly in situations in which
the company is not performing up to expectations
and the company refuses to adjust the pre-money
value of a financing round accordingly. However, the
provision penalizes existing investors, rather than
management, for non-performance. In effect, the
pay-to-play requirement may cause excessive funding
in poorly performing companies.
likely to ask the founders to make representations and
warranties about the ownership of intellectual property and any related license agreements, especially
if the company is an academic start-up.
Conditions to Closing
Standard conditions to closing include satisfactory
completion of due diligence (legal, financial, intellectual property, etc.), qualification of shares under
applicable Blue Sky laws19, filing of the Charter, and a
clean opinion from the company’s counsel regarding
the financing.
Expense Reimbursement
Open to negotiation (and leverage considerations) is
the company’s obligation to pay or reimburse investors’
legal and administrative costs related to the financing.
Customarily, this obligation is voided if the investor(s)
do not complete the financing without cause.
The Investor Rights Agreement
Registration Rights
Registration rights are important to investors, as
well as to founders and management. These rights
describe conditions enabling them to register their
shares for sale to the public. These rights are increasingly customary and standard, and in essence, provide
that upon conversion of the shares to common, the
shares become “registrable securities” and thereby
tradable under Securities Act Rule 144.20
Investors also generally demand registration rights
requiring the company to register for sale preferred
investors’ shares after an agreed upon number of
years (e.g., three to five) following the company’s
initial public offering (“IPO”).
Lock Up
Lock up is an agreement that existing investors will
not sell or otherwise transfer their shares for a limited
period of time, e.g. 180 days, typical in connection
with an IPO. Locking up existing stockholders for
a period of time is a customary request/demand by
investment bankers underwriting an IPO. The lock
up typically restricts company “insiders,” that is, officers, directors, founders, and preferred sharehold-
Stock Purchase Agreement
Typical VC financing term sheets include a small
number of terms which are detailed in the SPA, including: representations and warranties, conditions
to closing, and expense reimbursement.
Representations and Warranties
The Company will be asked to make what investors
consider “standard” representations and warranties
regarding the state of the company. Investors are also
34
les Nouvelles
19. State laws regulating the offering and sale of securities to
protect the public from fraud.
20. Rule 144 provides an exemption and permits the public
resale of restricted or control securities if a number of conditions are met, including how long the securities are held, the
way in which they are sold, and the amount that can be sold
at any one time, after the restrictive legend on the back of the
security has been removed by a transfer agent. http://www.sec.
gov/answers/rule144.htm.
Venture Capital 101
ers, from selling their shares during the agreed upon
period. Even if such restriction in not in the financing
documents, it is more likely than not that investment
banker(s) underwriting the IPO will require a lock
up. However, the institution’s founding stockholding
share may be so small at the time of the IPO that it is
not required to sign the lock up, and in that case, may
be advised not sign and thereby preserve its option
to sell soon after the IPO. Management Rights Letter
VCs often require a management rights letter. In
the letter will be authorization for certain investors
to attend Board meetings, as observers if they are not
members of the Board, advise and consult with management of the company, and inspect the company’s
books and records. VCs require these rights in order
to obtain an exemption from regulations under the
Employee Retirement Income Security Act (ERISA) of
1974.21 Prior to closing the financing, investors are
likely to also require reasonable access to the company’s facilities and personnel for due diligence.22 In
the Management Rights Letter, the company agrees
to provide investors with annual, quarterly, and occasionally monthly financial statements and other
information provided to the Board of Directors. In
addition, the company agrees to provide investors
annually with a comprehensive operating budget and
capitalization table.
Right to Participate Pro Rata in Future
Financing Rounds
It is customary and standard for investors to be
granted the right to participate, pro rata their percentage equity ownership, in subsequent issuances
of equity (future financing rounds), not including
21. Absent an exemption, if a pension plan subject to ERISA
is a limited partner in a venture fund, then all of the venture
fund’s assets are subject to regulations that require the venture
fund assets to be held in trust, prohibit certain transactions, and
place fiduciary duties on fund managers. However, a Venture
Capital Operating Company (“VCOC”) is not deemed to hold
ERISA plan assets. To qualify as a VCOC, a venture fund must
have at least 50 percent of its assets invested in venture capital
investments. In order to qualify as a venture capital investment,
the venture fund must receive certain management rights that
give the fund the right to participate substantially in, or substantially influence the conduct of, the management of the portfolio
company. In addition to obtaining management rights, the fund
is also required to actually exercise its management rights with
respect to one or more of its portfolio companies every year.
http://www.startupcompanylawyer.com/2007/12/03/what-is-amanagement-rights-letter/.
22. Investors who are competitors or who have competitive
interests may not be afforded such rights to information.
certain exempted issuances (e.g., issuances of stock
options for employees). In the event that an investor elects not to purchase its full pro rata share in a
future financing round, other investors have the right
to purchase the remaining pro rata shares.
Right of First Refusal/Co-Sale Agreement
This agreement grants to the company first and the
investors second the right of first refusal to purchase
shares offered for sale by founders and gives the
investors the right to sell a portion of their shares as
part of any sale of shares by the founders.
Voting Agreement
Board of Directors
A new Board is trypically put in place at the closing
of a financing round. Investors are likely to want a
majority of the Board to include representatives of the
investors, the CEO, and perhaps another independent
person or two who are not employed by the company
and who are mutually acceptable to founders, management, and the new investors.
Drag-Along Right
The drag-along right requires shareholders to vote
their shares in favor of a sale of the company, which
is approved by the Board and holders of an agreed
on percentage of outstanding shares.
Other Matters
No Shop / Confidentiality
The no shop / confidentiality provision requires the
company to work in good faith to close the financing and restricts the company and its founders for
an agreed upon period of time (e.g., weeks) from
soliciting, initiating, encouraging, or assisting any
competing financing proposal. This provision further
requires the company not to disclose terms of the
term sheet.
Conclusion
For those unfamiliar with venture capital, this
article has sought to demystify their financing mentality, jargon, and documents. Given the increasing
number of deprioritized R&D assets and projects
being spun-out of from large and small biopharmaceutical companies into new ventures, industry
licensing executives need to become familiar with
the attitudes, language, and deal structures of VCs.
Likewise, academe is more likely than not to continue
to seek to commercialize their most interesting new
discoveries via start-up ventures. Understanding deal
terms that matter to institutional investors is important for both academic technology transfer managers
and industry licensing executives. ■
March 2014
35
Venture Capital 101
Appendix A: License Term Sheets
Customary and standard licensing jargon and term
sheets used by not-for-profit (academic) research
institutions23 generally focus on:
• The IP to be licensed, including the extent to which the rights are being granted extend
to corresponding foreign counterparts and other extensions (e.g. continuation, continua-
tion-in-part, divisional, and re-issue patents
and patent applications);
• Scope of rights being granted (e.g. exclusive worldwide license, field of use, right to
sublicense, to make, have made, use, import, sell, and offer for sale licensed products);
• Financial considerations:
• Up-front payment in cash and/or equity;
• License maintenance fees;
• Royalties—running and minimum;
• Sublicense fees and sublicense revenue
sharing obligations;
• Milestone payments; and
• Sponsored research funding;24
• Risk management provisions:
• Warranties;
• Indemnification;
• Representations; and
• Insurance obligations;
• Reporting, audit, and information rights:
23. See Appendix A for a model academic licensing term sheet.
24. A number of institutions are increasingly using licenses to
start-ups to generate near-term sponsored research support for
investigators and value such funding as a productivity metric.
36
les Nouvelles
• Progress reports (including an example
of an acceptable report);
• Audit rights and sales records; and
• Royalty reports (including an example
of an acceptable report);
• Equity considerations (in licenses to start-ups
with equity):
• License initiation equity;
• Representations and warranties;
• Voting and dividends;
• Covenants;
• Piggyback and S-3 registration rights;
• Redemption rights;
• Participation (preemptive) rights;
• Right of first refusal;
• Co-sale right;
• Drag-along right;
• Certification/Articles of Incorporation;
• Other provisions:
• Confidentiality;
• Reservation of rights;
• Due diligence obligations;
• Use of name restrictions;
• License completion timetable; and
• Binding/non-binding nature of the Term Sheet.25
25. For a more extensive discussion of term sheets, see Berneman, L.P., Denis, K.A. and Wright, C.F. “Using Term Sheets
to Get What You Need and Negotiate for What You Want in
Industry-University Licenses,” in Association of University Technology Managers Technology Transfer Practice Manual, Marjorie
Forster, editor, 2003 and later editions.
Exhaustion Theory Part 3
The Exhaustion Theory Is Not Yet Exhausted
Part 3
By Erik Verbraeken
Y
ear 2013 has been rich in the issuance of various
court decisions, from the Supreme Court to the
District Courts, that provide further guidance on
the application of the intellectual property exhaustion
doctrine (a.k.a. the “first sale” doctrine) to sales of
products made by unauthorized third parties.
Without giving an exhaustive overview of all judicial
cases that may have been tried in 2013, this article
will focus on the following six decisions: (1) Kirtsaeng
vs. John Wiley Inc. (Supreme Court March 19, 2013),
(2) Bowman vs. Monsanto (Supreme Court May 13,
2013), (3) Capitol Records vs. Redigi (NY District Court
March 30, 2013, (4) Keurig vs. Sturm Foods (Federal
Circuit October 17, 2013), (5) Lifescan Scotland vs.
Shasta Technologies (Federal Circuit November 4,
2013), and (6) Tessera vs. ITC (Federal Circuit May
23, 2011). In addition, this article will comment on
these decisions from a EU perspective, where in some
instances similar, but in other cases radically different
decisions have been given.
1. Kirtsaeng vs. John Wiley (U.S. Supreme
Court March 19, 2013, 568 U.S. ___, 2013)
Since the Supreme Court has given its patent
exhaustion milestone decision in Quanta vs. LG Electronics in 2008, 2013 has provided the opportunity
for a further ground breaking decision in the area of
copyright in a matter opposing Mr. Supap Kirtsaeng, a
Thai student studying in the USA, against John Wiley
& Sons, a global publishing company that specializes
in academic publishing. Since this decision has also
been discussed in the John Paul & Brian Kacedon
section of “Recent U.S. Decisions” in les Nouvelles of
June 2013, I will only give a summary of the essential
facts and findings in this article.
Kirtsaeng vs. John Wiley centered around the question whether the U.S. copyrights owned by John Wiley
on textbooks that it publishes on a worldwide basis, can
be opposed against an individual (or corporation) that
purchases these books in a foreign jurisdiction in order
to import and sell the latter in the USA. In other words,
are U.S. copyrighted works subject only to a national
exhaustion rule or to an international exhaustion rule?
In a nutshell, the Supreme Court ruled in favor of Mr.
Kirtsaeng (and hence, in favor of the international exhaustion of copyright) on the basis of the following findings:
(a) relying on a textual interpretation of the relevant provisions of the Copyright Act, also in light
of the historical and contemporary statutory context, the Court found no foothold in the language
of these provisions supporting the argument of
John Wiley that the “first sale doctrine” should not
apply to copyrighted works lawfully made abroad;
“lawfully made under this title” as mentioned
in section 109(a) of the Copyright Act does not
restrict the scope of this article geographically.
(b) besides this textual interpretation, the Court
also addresses the “parade of horribles” that
■ Erik Verbraeken,
would be the result of
Johnson Controls,
a geographical limitaDirecteur Juridique France,
tion, by pointing out
& Sr. Legal Counsel EMEA,
the “intolerable consequences” that would
Colombes, France
result for the marketE-mail: [email protected]
place when the “first
sale” doctrine would
be limited to “made in the USA” works only; foreign
manufactured copyrighted products that, today but
also tomorrow, represent high volume commercial
transactions (“retailers tell us that over $2.3 trillion
worth of foreign goods were imported in 2011”)
would be barred from importation into the USA unless specific permission from the copyright holder
would be obtained, and would thus be barred from
further second-hand sales within the USA.
The Kirtsaeng decision is not only of paramount
importance from a legal perspective in that it applies
the international exhaustion doctrine not only to
products manufactured domestically for which the
first sale occurred abroad (Quality King Distributors
vs. L’anza Research), but also to products manufactured abroad; it may also create shockwaves from a
economic perspective in that international exhaustion
will undermine market differentiation practices where
companies adjust their prices to what the local market
is anticipated to bear. As mentioned in the dissenting
opinion to the Supreme Court decision, “To protect
their profit margins in the U.S. market, copyright owners may raise prices in less developed countries or may
withdraw from such markets altogether”— raising the
specter that companies may abandon sales in low profit
countries when they fear that such sales may later
cannibalize their operations in higher profit countries.
Also, this decision may have significant consequences
from a commercial perspective because “the natural
March 2014
37
market response after Wiley would be for publishers
to turn to digital distribution, where publishers may
retain full control under prevailing digital licensing
models” (cf. “Kirtsaeng vs. Wiley Incentivizes Digital
Distribution” from Ilaria Maggioni in les Nouvelles of
December 2013).
Finally, this decision demonstrates a watershed
between the approaches to international exhaustion
within the U.S. on the one hand and within the EU
on the other hand. As the dissenting opinion of judge
Ginsburg puts forward, international exhaustion is
a “highly contentious trade issue” and the Court’s
position risks undermining the U.S. credibility on the
world stage, by issuing a ruling that is at odds with the
stance taken by U.S. authorities in international trade
negotiations on this subject-matter.
Indeed, the Court of Justice of the EU has ruled
against international exhaustion for trademark rights
in the Silhouette decision of July 16, 1998, and more
in particular for copyrights in the Laserdisken decision
of September 12, 2006, relying on the objective of the
common market pursued by the Member States under
the EU Treaty, i.e. to safeguard the functioning of the
internal market, implying that a situation in which
some Member States could provide for international
exhaustion while others provide for Community exhaustion only would “inevitably give rise to barriers
to the free movement of goods and the freedom to
provide services.” Exhaustion of rights is accepted
within the EU as of regional (i.e. between EU Member
States) application only, in order to foster the unity
and integrity of the internal market. Worldwide international exhaustion on the other hand is a commercial
policy instrument, and as the Advocate General Jacobs
alluded in the Silhouette decision, should be part of a
multilateral trade arrangement based on reciprocity.
Whereas the Kirtsaeng decision has now unconditionally embraced the international exhaustion doctrine for copyrights, the question remains whether the
same logic applies to patent rights and trademark rights
… and any other IP rights in general. In other words,
can this decision of the Supreme Court automatically
be extrapolated to the trademark and patent context?
For trademarks, it is generally recognized that trademarked goods may be imported if they emanate from
a foreign affiliated company of the brand owner and
the goods do not differ materially from those marketed
in the United States. However for patents, until now,
the Federal Circuit has held that patent rights are
only exhausted through domestic sales, excluding the
application of this doctrine to foreign sales that are
subsequently imported into the USA: Jazz Photo Corp.
v. International Trade Commission (Fed. Cir. 2001);
Fujifilm Corp. v. Benun (Fed. Cir. 2010).
38
les Nouvelles
Will Kirtsaeng consequently be a precursor for the
reversal of the “national-only” patent exhaustion theory
for patents? On the one hand, it can be argued that
whereas the international exhaustion has been accepted
for trademarks and for copyright, there is no compelling
reason why it should not be accepted for patent rights.
In addition, the practical issues put forward by the Supreme Court in Kirtsaeng for copyrighted works apply
likewise for patented products: “automobiles, microwaves, calculators, mobile phones, tablets and personal
computers contain copyrightable software programs”
(like they will probably contain patented compounds and
parts) and “a geographical interpretation would subject
many, if not all, of them to the disruptive impact of the
threat of infringement suits”—identical issues that in
all likelihood will exist for patented goods.
On the other hand however, the copyright related
ruling of the Supreme Court in Kirtsaeng was anchored
on the statutory and historical interpretation of Section 109(a) of the Copyright Act, whereas the patent
exhaustion doctrine finds no basis in any U.S. statute,
and has found its origin in judicial constructions since
the first case of Adams vs. Burke in 1873. The Supreme
Court has recently been offered an opportunity to confirm or infirm its holdings within the patent context in
the wake of the Kirtsaeng decision through a writ for
certiorari in the matter of Ninestar Technology Co. v.
ITC, but the writ has been denied by the Court.
The patent context is also more complicated than
the copyright context, making a “peer-to-peer” comparison (and possible extrapolation) perilous. The
fundamental difference between a copyright and a
patent right is that the first right originates automatically through the mere creation of the work, giving
birth to a (quasi) universal perimeter of protection
(1886 Berne Convention) whereas the patent right is
only obtained through a patent application followed
by a patent grant, giving birth to a national perimeter
of protection. Consequently, patent protection comes
with a patent strategy, where a company will decide
on a country-by-country basis, using a cost-benefit
analysis, whether to apply for (and maintain) a patent
in each respective country; copyright on the other
hand does not need to be nationally registered and title
stems from the mere creation of the work.
The importation of a product that is lawfully made
and sold in a country where the U.S. patentee has
decided not to file (or maintain) a patent, should therefore not automatically be subject to the exhaustion
theory, because the patentee has decided not to incur
the filing (and maintenance) cost and (likewise) not to
reap the potential monopoly profits for the patented
product in this country; whilst, in analogy with Adams
vs. Burke, the application of the exhaustion theory can
be defended on the basis that the patentee “receives
the consideration for its use and […] parts with the
right to restrict that use,” it nevertheless remains a
fact that the patentee has not received the monopoly
consideration which he could have extracted when the
sale would have been a patented sale. Consequently,
the same economic concerns apply as those that were
put forward in Kirtsaeng, i.e. (to quote the famous
law of Murphy) “bad sales (of non-patented products)
drive out good sales (of patented products)” opening
a back door through which these products, sold under
competitive conditions in a non-patented country, can
undermine the price policy applied by the patentee
in those countries where he has elected to file and
maintain a patent.
This same discussion has been held in the EU as part
of the pharmaceutical saga of Merck vs. Stephar (ECJ
decision of 1981) and vs. Primecrown (ECJ decision of
1997), where Merck opposed the importation of pharmaceutical products that it had sold, respectively, in
Italy and in Spain and Portugal (where no patent rights
were granted for pharmaceutical products at that time)
into the UK, because the sales in those non-patented
countries did not allow Merck to obtain “a return to
the inventor to compensate for the costs of research”
when they were subsequently introduced into the
UK. Although the arguments of Merck were dismissed
twice by the European Court of Justice (“It is for the
proprietor of the patent to decide, in the light of all the
circumstances, under what conditions he will market
his product, including the possibility of marketing it in
a Member State where the law does not provide patent
protection for the product in question. If he decides
to do so he must then accept the consequences of his
choice as regards the free movement of the product
within the Common Market”), the opinion of the Advocate General Mr. Fennelly in the second Merck case
demonstrates the same hesitation as the one displayed
by dissenting judge Ginsburg in Kirtsaeng (“The effect
of the rule would be that, in order to avoid damage to
the value of its national patent rights in those Member
States which protect them, the patentee is encouraged
to partition the Common Market in a different way, i.
e. through refusing to supply units of its products to
the markets of those Member States where his rights
arc not recognized: […] in other words, it would favour
commercially irrational decisions to withhold products
from the markets of such States, where sales of the
product would hold out some prospect of profit”).
Finally, a salient detail of this decision that has largely
gone unnoticed, is that the textbooks purchased by
Mr. Kirtsaeng in Thailand contained the following
notice: “This book is authorized for sale in Europe,
Asia, Africa and the Middle East only and may not be
exported out of these territories. Exportation from or
importation of this book to another region without the
publisher’s authorization is illegal and is a violation
of the publisher’s rights.” This notice made the sale
conditional, and since the decision in Mallinckrodt vs.
Medipart (Fed. Cir. 1992), post-sale restrictions prevent the application of the exhaustion doctrine, unless
those restrictions violate some other policy such as
the antitrust rules. Could this clause have saved John
Wiley against the exhaustion of his rights through a first
sale? I do not have the impression that this argument
has been brought up before the court (the issue is not
broached at all by the Supreme Court), but nothing is
as sure as the 2008 Quanta vs. LGE decision, which
upheld the exhaustion of rights despite the use of
restrictive notices on the product. The effects that
restrictive covenants, whether through limited licenses
or post-sale restrictions, may have on the application of
the exhaustion theory remain therefore open-ended.
2. Bowman vs. Monsanto (U.S. Supreme
Court May 13, 2013, 569 U.S. ___, 2013)
This decision has been addressed as well in the
section “Recent U.S. Decisions” of les Nouvelles
(September 2013), and I refer to the overview given
therein for a more detailed background of this case.
The unique issue at stake in this case was the nature
of the product: self-replicating seeds (soybeans). The
seeds, when grown, result in plants containing themselves the very same seeds. Consequently, by selling
only one seed, theoretically the purchaser acquires an
unlimited number of seeds since the resulting crop can
be used over and over again for successive planting and
harvesting of the seeds.
In order to avoid this type of “nuclear chain” reaction, Monsanto sold the seeds under terms of agreement whereby the purchaser was allowed to plant
the purchased seeds in one season; the resulting crop
should then either be consumed or sold as a commodity
to downstream processing companies.
When Mr. Bowman used the seeds for successive
plantings and Monsanto became aware of this practice,
he sued Mr. Bowman for infringement. The defense
of exhaustion was unanimously dismissed by the
Supreme Court: patent exhaustion does not permit a
farmer to reproduce patented seeds through planting
and harvesting without the patent holder’s permission.
Although the decision by itself is not surprising,
there is one trait that has remained unexplored and
that could have provided for more interesting developments. In fact, according to the facts exposed in the
ruling, Mr. Bowman proceeded in three steps: (1) he
purchased the seeds each year from Monsanto for his
first crop of the season; (2) he purchased “commodity
March 2014
39
soybeans” from a grain elevator and planted these for
the second “late season” crop; (3) of the plants growing
out of this second planting, he saved the seeds for his
second (third, fourth, etc.) year’s “late season” planting.
There is no doubt that step 1 is authorized (legitimate licensed use) and step 3 is unauthorized (reproduction of patented article). But under the second
step, Mr. Bowman was using the seeds in accordance
with its very nature, i.e. for planting; the only (fundamental) difference being that under the first step, he
purchased the seeds from Monsanto under the terms
of a restrictive license agreement; whereas under the
second step, he purchased the seeds from a grain
elevator under the terms of a sales agreement which
(as far as I am aware, the details were not provided in
the decision) did not restrict the purchaser in the use
of the product. There was no replication under this
second step as there was in the third step; under the
second step (like under the first step), Mr. Bowman
purchased a seed in order to plant the same and grow
consumables, while under the third step, Mr. Bowman
replicated the seeds in order to grow seeds (and maybe
consumables). The second step is different from the
first step only with regard to the source of the supply
(manufacturer under the first step, wholesaler under
the second step) and the nature of the product (sale as
a seed under the first step, sale as a commodity under
the second step).
The question is therefore: where the seed is conditionally sold under the first transaction (from Monsanto to farmer A) with the “single use” restriction
that the seeds were only to be planted in one season,
and the soybeans grown from that first planting are
subsequently unconditionally sold from farmer A to
the grain elevator and, subsequently, from the grain
elevator to Mr. Bowman (it does not appear from the
Monsanto license agreement that the purchaser had to
impose the same limited license conditions to future
purchasers, and even if that were the case, it does
not appear that the grain elevator did indeed impose
these same restrictions on Mr. Bowman), would Monsanto still have been able to oppose his patent right
accordingly against Mr. Bowman? This issue remains
outstanding since the latent bifurcation in Quanta vs.
LGE on the one hand and Mallickrodt vs. Medipart
on the other hand on the effect of sales restrictions
on the exhaustion (or not) of the underlying patent
right. The Supreme Court simply deducts that under
the second step, Mr. Bowman produced additional
patented soybeans without Monsanto’s permission.
This is true, but the dual nature of the product (commodity and seed at the same time) plus the purchase
thereof on the marketplace without any restrictive
covenant, whether as a notification on the package
40
les Nouvelles
or through the general conditions of sale, leaves open
the question if the patent right should nevertheless
not be considered as exhausted—albeit subject to the
particular circumstances of this case where Mr. Bowman was very much aware of the user limitations with
respect to soybean seeds he purchased as a result of
his previous transactions with Monsanto (cf. General
Talking Pictures vs. Western Electric [Supreme Court
1938] where exhaustion was precluded because the
purchaser was deemed to have known of and actively
induced breach of the field of use license restrictions).
If we make the parallel with EU law, it is not certain
that the ECJ would have come up with the same result—although it is difficult to anticipate the Court’s
decision having regard to the specific self-replicating
nature of this product. The ruling of the Court in the
Peak Holding vs. Axolin decision (2004) leaves no
doubt as to the effect that restrictive contract clauses
may have on the patent right: “Exhaustion occurs
solely by virtue of the putting on the market in the
EEA by the proprietor. Any stipulation, in the act of
sale effecting the first putting on the market in the
EEA, of territorial restrictions on the right to resell
the goods concerns only the relations between the
parties to that act. It cannot preclude the exhaustion
provided for by the Directive.”
The question is also whether the economic rationale
put forward by the Supreme Court is convincing. At
stake is the factual finding that “the grower could
multiply his initial purchase, and then multiply that
new creation, ad infinitum—each time profiting from
the patented seed without compensating its inventor.”
But this very much depends on the business model
applied by the vendor—like a standard royalty deal,
where the patentee can either license under a “per
unit” formula (running royalty) or a “all-in” formula
(lumps sum payment), so the seed manufacturer can
sell the seed under a “single use” formula or a fully
capitalized price, discounting for the loss of future
revenue as a result of the self-replicating nature of the
product. The downstream purchaser of soybeans does
not know what business model the seed manufacturer
has applied at the instance of the first sale—even
more so when the downstream sale has been made
without accessory use limitations. The argument of
Mr. Bowman that “seeds are meant to be planted” is
not without merit in this perspective—always subject
to the personal knowledge that he had of the sales
conditions applied by Monsanto.
Moreover, it may be scientifically questioned
whether after a first purchase, the seed could be
multiplied ad infinitum; the constant exposure of the
seed to (in this case) aggressive herbicides (Round-up)
may suppose that the resistant properties of these
seeds, object of the patent, will diminish and vanish
over time. Consequently, there will always remain a
market for first-sale seeds, despite the self-replicating
nature thereof.
The Monsanto-Bowman decision remains thus of a
limited interest: not only because of the very nature
of the infringing act (reproduction of self-replicating
seeds), but also because of the case-specific ruling that
the Supreme Court itself pronounced at the end of its
ruling: “Our holding today is limited—addressing the
situation before us, rather than every one involving a
self-replicating product. We recognize that such inventions are becoming ever more prevalent, complex, and
diverse. In another case, the article’s self-replication
might occur outside the purchaser’s control. Or it
might be a necessary but incidental step in using the
item for another purpose.”
So in this area as well, the exhaustion theory is not
yet exhausted!
3. Capitol Records vs. ReDigi (U.S. District
Court NY, March 30, 2013, 12 Civ. 95)
This software exhaustion case is very similar to the
EU case of Oracle vs. UsedSoft and provides another
example of where the U.S. and EU vision on exhaustion of rights differ.
In this case, ReDigi positioned itself as an online
marketplace for the purchase and sale of “second-hand”
digital music files. Upon purchase, the buyer downloads
the music file which is concurrently deleted from the
seller’s computer.
Since the transfer protocol for the digital transmission of the music file requires an initial uploading of
the latter on the servers of ReDigi, and a subsequent
download on the computer of the purchaser, the District Court found that there was no resale of an original
product, but a reproduction of the copyrighted code
embedded in new material object (respectively, the
ReDigi servers and the buyers hard drive).
Applying a linguistically correct, but technologically
obsolete, interpretation of Section 106 of the Copyright Act, the court holds that “the first sale defense is
limited to material items, like records, that the copyright owner put into the stream of commerce, and then
relies on the “law of physics” in order to establish that
“it is simply impossible that the same ‘material object’
can be transferred over the Internet.” Consequently,
as an unlawful reproduction, a digital music file sold
on ReDigi is not “lawfully made under this title” as
set forward in Section 109(a). Whilst the purposive
construction of the Copyright Act sought by ReDigi in
the new era of technological change has not rendered
the provisions of Section 109 any less ambiguous, the
Court simply points out that what ReDigi is trying to
establish is an amendment of the Copyright Act, which
is “a legislative prerogative that courts are unauthorized and ill suited to attempt.”
Like in Wiley vs. Kirtsaeng, an interesting economic
comparison creeps around the corner. Without explicitly saying so, the District Court seems to imply that
the public policy rationale underlying the exhaustion
doctrine finds its source in the devalued properties
of traded goods, which means that the level-playing
field of the IP right-holder in relation with sales of
his patented (or copyrighted) products remains ringfenced against too important erosive effects exercised
by the exhaustion theory, because (quoting the U.S.
Copyright Office report on the digital millennium)
“physical copies of works degrade with time and use,
making used copies less desirable than new ones.
Digital information does not degrade, […] the used
copy is just as desirable (in fact, is indistinguishable
from) a new copy of the same work. […] The ability
of such used copies to compete for market share with
new copies is thus far greater in the digital world.”
While this observation is certainly correct, this does
not change in any way the century-old principle behind
the exhaustion theory that when the IP right-holder
has sold the good subject of the IP right, “he receives
the consideration for its use and he parts with the
right to restrict that use” (Adams vs. Burke); see also
Princo Corp. v. ITC (Fed.Cir.2010) holding that the
unconditional sale of a patented device exhausts the
patentee’s right to control the purchaser’s use of that
item thereafter because the patentee has bargained
for and received full value for the goods.
The legal rationale for this decision, while convincing
on face value, remains fragile. Although digital works
are not in the strict sense of the words “sold,” but
distributed on the basis of a limited license, it cannot
be denied (at least in relation with transfers implying
physical tangible media like CD-ROMs or DVDs) that
like any other copyrighted work, a change of title of
the support material takes place (equivalent to a sale)
whilst the editor retains property rights in the contents
(equivalent to a license). The explanation given in the
December 2013 contribution of Ilaria Maggioni (see
above chapter 1) that “the fundamental difference
between a physical and digital product is the nature
of the legal transaction that is used to handle digital
versus non-digital works,” i.e. non-digital works are
transferred through an actual sale and digital works
under a limited license, is only one side of the medal
because it reflects current practices. However, faced
with the legal consequences, nothing prevents book
publishers and record companies, eager to stop the
“bleeding” caused by the first sale doctrine, to strucMarch 2014
41
ture their book and record sales as limited licenses.
This same duality was recognized by the European
Court of Justice in the 3le vs. UsedSoft case (2011)
that I have reviewed in detail in les Nouvelles of March
2013. Parting from an entirely different perspective
as the NY District Court, the ECJ held that “from an
economic point of view, the sale of a computer program
on CD-ROM or DVD and the sale of a program by
downloading from the internet are similar. The on-line
transmission method is the functional equivalent of the
supply of a material medium.” Consequently, in consideration of making available for downloading a copy
of the computer program with the intention of making
the copy usable by the customer on a permanent basis,
“in return for payment of a fee designed to enable the
copyright holder to obtain a remuneration corresponding to the economic value of the copy of the work of
which it is the proprietor,” the essential function of
the copyright has been fulfilled. As Advocate General
Bot puts it in his conclusions for this case, “Allowing
him to control the resale of that copy […] would have
the effect not of protecting the specific subject-matter
of the copyright but of extending the monopoly on the
exploitation of that right.”
In a statement, ReDigi said it was “disappointed”
by the ruling and would appeal it, but so far no action
seems to have been undertaken.
4. Keurig vs. Sturm Foods (Fed. Cir. Court of
Appeals October 17, 2013, no. 2013–1072)
Keurig manufactures and sells coffee brewers and
cartridges for use in those brewers. This is probably
the invention that most of us use every day: insert
the cartridge into the brewer, the hot water will run
through the cartridge, and your cup of coffee is ready.
Keurig owned patents directed both to brewers and
to methods of using them to make beverages—the
present case concerns the method claim.
Sturm manufactures and sells cartridges for use in
Keurig’s brewers, and was sued by Keurig for inducing
infringement of its method patent.
Contrary to the two milestone decisions of the
Supreme Court in method claim exhaustion, United
States v. Univis Lens (1942) and Quanta vs. LGE (2008)
that dealt with unpatented products sold to a third
party who subsequently used these products as part
of the (patented) method, the product sold in this
case was a patented product (brewer) whose claims
extended to “a method of brewing a beverage from a
beverage medium contained in a disposable cartridge.”
This little detail did not dissuade the Court in restating the application of Quanta: “Keurig sold its patented
brewers without conditions and its purchasers therefore obtained the unfettered right to use them in any
42
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way they chose, at least as against a challenge from
Keurig,” adding that “Here, Keurig is attempting to
impermissibly restrict purchasers of Keurig brewers
from using non-Keurig cartridges by invoking patent
law to enforce restrictions on the post-sale use of its
patented product.” Its conclusion is, therefore, that
“The claims of both the ‘488 patent and the ‘938
patent are directed to the brewers and the use of the
brewers; therefore, Keurig cannot preclude an individual who purchased one of its brewers from using a
non-Keurig cartridge with that brewer.”
Interestingly, a similar case was judged nearly simultaneously in the UK (Nestec vs. Dualit), where Nestec
accused Dualit of supplying an essential element of
the patented system, thereby practicing an act of
contributory infringement. The High Court considered that the consumer did not “make” the system as
claimed in the patent when he used one of Dualit’s
capsules in a Nespresso machine: the capsule was an
entirely subsidiary part of the system. “By consenting
to the manufacture and sale of Nespresso machines,
Nestec have exhausted their rights under the patent
to restrict purchaser’s freedom to use such machines
in accordance with their normal function.”
The devil is in the detail and both the U.S. and the
UK decision contain an important qualification to the
ruling: the machines were sold in both cases “without
conditions.” Which means that we get back to square
one: if such restrictive conditions would have been
introduced, could the supplier of brewer machines
have opposed its patent rights against subsequent independent suppliers of coffee cartridges? Both decisions
seem to imply this consequence, which makes the
need for a definitive ruling on this matter even more
pressing. Quanta did not make the “quantum leap” that
many hoped for which makes that the current state
of the law can still be interpreted as authorizing the
supplier, by introducing restrictive conditions in his
agreement, to “have your pudding and NOT eat it too.”
The German District Court has also accepted the
exhaustion of the patent right of Nespresso with the
sale of the Nespresso machines, since the use of these
machines by the consumers with capsules of third parties forms part of the intended use of those machines.
The coffee war is still lingering and more will probably
be said on this subject in Part 4 of this Exhaustion series.
5. Lifescan Scotland vs. Shasta Technologies
(Fed. Cir. Court of Appeals November 4, 2013,
2013-1271)
And not only is the coffee war still lingering, the
method exhaustion battle itself is also still ravaging, as
demonstrated by the Lifescan vs. Shasta Technologies
decision, that involved two determinative “method
exhaustion” questions: (1) when can a product be
said to “embody the essential features of a patented
method,” and (2) is exhaustion triggered when the
patentee provides the product incorporating such essential features for free?
In this case, the patented method consisted in a
combination of an electrochemical meter and disposable test strips equipped with two separate working
electrodes (instead of one compared to the prior art)
in order to measure blood glucose levels; the invention claimed an improved reading because the system
permitted to detect inadequate sample volumes or
operational defects if the readers of the two electrodes
differed significantly.
The first interesting aspect of this case lies in the
entirely different interpretations related to the application of the method claim exhaustion by the majority
opinion formulated by judge Dyk on the one hand and
the dissenting opinion written by judge Reyna on the
other hand: where the majority opinion retained that
“the undisputed facts, the specification of the patent,
and the prosecution history all suggest that the claimed
inventive concept of the method claims of the ‘105 patent lies in the meter, rather than the strips, because the
meters ‘control’ and ‘carry out’ the inventive functions
of the method claims,” the dissenting opinion considers that “but for the specialized test strips required by
LifeScan’s patented method, the blood glucose meter
alone could not perform the ‘comparing’ and ‘giving
an indication of an error’ steps viewed by the majority
as essential to the patented method.”
The discord between the respective opinions calls
into question whether the “essential features” test is
really the appropriate test for distinction, since in a
combination claim A+B where one of the elements
is not entirely standard as was the case in Quanta,
each element is essential to the working of the other.
Would the ruling have been different if instead of
Shatsa supplying disposable test strips, it had supplied
the meter equipment (if supposedly the apparatus had
been unpatented which was not the case in LifeScan)
holding that the method claim was exhausted by the
sales of test strips by LifeScan to a customer? If we draw
the parallel with the coffee case, by simply buying the
(patented) capsule from a Nespresso store, the purchaser would he be exempt from patent infringement
(and the supplier from contributory infringement) if
he had acquired the (non-patented) equipment from
Keurig / Dualit since the capsule was an essential element designed to fit this type of equipment ? Method
claims by definition imply an interlocking of different
elements that, working together, represent the inventive feature of the product; focusing on one of these
elements rather than the other as being “essential” may
therefore appear artificial, since the one is incomplete
without the other.
A more distinctive test may be to rely on the second
holding of the Quanta court, i.e. do the products have
a reasonable alternative noninfringing use? If a product
A marketed by the patentee has no reasonable noninfringing (and, I’d like to add, “substantial”) use besides
the practice of the patented method claim, then it must
be held that the method patent on the combination
A+B is exhausted when a customer purchases A and
uses this product, in accordance with its intended
purpose, in combination with B, even if product B also
can be said to substantially embody the patent. This
perspective may have been part of the ruling in Keurig
when the court held that a potential noninfringing
use prevents exhaustion when the use in question is
the very use contemplated by the patented invention
itself. Another possible criteria of distinction can be
found in the UK High Court’s reference to the capsule
being altogether of a subsidiary nature having regard to
the entire patented claim; like the micro-components
were under Quanta and the lens blanks under Univis.
In order to demonstrate the working of this test, I’d
like to refer to the example that I used in my September 2009 article for les Nouvelles, “Drafting of Royalty
Clauses: 30 Ways to Head for Windfall or Pitfall,” i.e.
a patentee that has developed an acid formula that is
capable of eliminating asphaltene formations in oil
wells. Besides the product patent, the patentee also
develops a method patent where the injection of this
compound in addition with certain (as in Quanta)
standard products under certain operating conditions (pressure, temperature, viscosity, …) delivers
an optimum result. Under this example, the working
of the method claim requires two essential patented
steps: the patented chemical formula and the patented
injection method. Both “substantially embody the
patented invention” making the application of this
part of the Quanta decision of relative value. But the
“reasonable alternative use” test allows to determine
whether the purchaser of the chemical product can
claim that the sale thereof has exhausted the method
patent: if the only “reasonable and intended” use of
such products is to inject the latter as described in
the method claim, then the method claim should
be considered exhausted. Under this example, this
would unlikely be the case: the method describes a
means to optimize the asphaltene formation inhibition, but this method is not the only reasonable and
intended means available to the oilwell operator:
the method described a “preferred means” without
culminating in an “exclusive means” (as in Quanta).
Whether or not the chemical compound was patented
or not would probably not influence the appreciation.
March 2014
43
The second important attribute of this decision
to the edifice of the exhaustion doctrine lies in its
majority ruling that the said doctrine is triggered by
“all authorized transfers of title, regardless of whether
the particular transfer at issue constituted a gift or a
sale.” According to the facts, Lifescan sells 40 percent
of its meters at below cost prices, while 60 percent is
distributed for free through health care providers, in
the expectation that users will purchase the Lifescan
test strips from which it derives a profit. Holding that
“none of the cases cited by Lifescan involved any suggestion that exhaustion could be avoided by showing
the absence or inadequacy of the patentee’s reward
in a transfer by gift,” the Court deducts that “where a
patentee unconditionally parts with ownership of an
article, it cannot later complain that the approach that
it chose results in an inadequate reward and that therefore ordinary principles of patent exhaustion should
not apply.” Likewise, judge Reyna dissents: “a patent
system premised on granting the patentee a ‘hope of
receiving a future benefit’ is one where there is no
secure benefit to be had and that does not promote
the progress of the useful arts.”
Inadequacy of reward is certainly not a valid motive
to prevent exhaustion to happen (cf. the Tessera decision reviewed under point 6). This has been clearly
recognized in the EU under the two Merck decisions
where the European Court explained that the patent
allows the patentee “a monopoly in exploiting his
product, to obtain the reward for his creative effort
without, however, guaranteeing that he will obtain
such a reward in all circumstances”; it is up to the
proprietor of the patent “to decide, in the light of
all the circumstances, under what conditions he will
market his product,” after which “he must then accept
the consequences of his choice.”
It seems to me that the question is more one of
commercial strategy pursued by the patentee: the latter
could have protected his business model by choosing
the appropriate contractual framework, rather than
relying of the strength of his patent claim. First, the
Court of Appeals concludes itself that the absence of
consideration is no barrier to the application of patent
exhaustion principles “in the case of an authorized
and unconditional transfer of title”—in other words,
LifeScan could have conditioned the gift of the meter
equipment to exclusive purchases of Lifescan test
strips, provided the exclusivity terms respect antitrust
legislation. Second, instead of a sale, Lifescan could
have provided the equipment under a rental or lease
arrangement, with the appropriate restrictive covenants of use. Third, if technically possible, LifeScan
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les Nouvelles
could have provided for the incorporation of a chip on
its strips readable only through an adapted scanning
device within the metering equipment. Even if the
contractual clauses would not have prevented Shasta
from commercializing its strips, LifeScan could have
acted under breach of contract against its customers—
including through a rescission of the sale or rental.
6. Tessera vs. ITC (Fed. Cir. Court of Appeals
May 23, 2011, n° 10-1176)
Although an older case, it is worth recalling to memory this case in relation with the preceding sections,
since it focuses on the essential question of authorized
vs. unauthorized sales. Tessera, confronted with sales
of its products under one of its patent licenses without
receiving payment of royalties in relation with these
sales, initiated an ITC action against an importer of
these products. The latter invoked the first sale defense
since it had legitimately acquired the product from a
licensee of Tessera, but Tessera opposed that since it
had never received the corresponding royalty payments
from this licensee, it cannot be considered to have
authorized such sale; whereas the patent exhaustion
theory has been developed in order to avoid “double
dipping,” Tessera argued that it had not even received
a “single recovery.”
The arguments of Tessera get short shrift from the
Court: “That some licensees subsequently renege or
fall behind on their royalty payments does not convert
a once authorized sale into a non-authorized sale.” The
Court continues “that absurd result would cast a cloud
of uncertainty over every sale, and every product in the
possession of a customer of the licensee, and would
be wholly inconsistent with the fundamental purpose
of patent exhaustion—to prohibit postsale restrictions
on the use of a patented article.”
Apart from the clarification of the Court that the
simple breach of contract by the licensee towards
its licensor does not thereby convert the sales made
by that licensee to third parties into potential patent
infringement situations for those customers, it also
seems that the Federal Circuit hereby accessorily pronounces the demise of the “scepter of Mallinckrodt”
by holding out, as a kind of “obiter dictum,” that the
fundamental purpose of patent exhaustion is to prohibit post-sale restrictions—of which the “single use”
restriction that was legitimized in the Mallinckrodt
case is the perfect example!
Whether or not the Federal Circuit has hereby explicitly drawn the consequences that remained only
implicit in Quanta, is…to be continued! ■
Value of License Agreements
By Louis P. Berneman, Todd C. Davis, D. Patrick O’Reilley and Matthew Raymond
agreements appropriate ■ Louis P. Berneman,
to their commercial poEdD, CLP, RTTP
tential and inherent risks
Texelerate,
LLC
(including, proof of cliniManaging
Director,
cal relevance, regulatory,
competition, intellectual Philadelphia, PA USA
property, and pricing/re- E-mail: [email protected]
imbursement). But licens- ■ Todd C. Davis,
ing professionals, and the
HealthCare Royalty Partners,
attorneys that support
them, need to structure Founding Managing Director,
agreements that reflect Stamford, CT USA
the goals and objectives E-mail: [email protected]
of the parties involved ■ D. Patrick O’Reilley,
today and well into the Finnegan, Partner,
future. In today’s market Washington, DC USA
nothing is standard. In
fact, it is often boilerplate E-mail: [email protected]
language or lack of com- ■ Matthew J. Raymond, PhD,
mon sense terms that Rush University Medical Center,
can derail or hinder the IP Office, Director of
use of licensed assets and Intellectual Property,
influence their long-term Chicago, IL USA
value. Flexibility, access, E-mail: [email protected]
clarity and protection are
critical when negotiating license agreements.
Introduction
B
iopharmaceutical companies and not-for-profit
(academic) research institutions have become
increasingly adept at structuring license and
related collaboration agreements. Year 2006 was the
most active year on record in nearly two decades with
1,615 licensing deals valued at $42.7 billion (see
Figure 1). But there has been a shift in strategy by
the large pharmaceutical companies, who continue to
lose patent protection on blockbuster products including Lipitor, Plavix, and Seroquel. This has compelled
these companies to shift their dealmaking, licensing
efforts and dollars to later stage assets to bolster
their pipelines.
In recent years, there has been a gradual increase in
research collaborations, co-promotion and marketing
agreements and royalty monetizations. In fact, these
transactions have outpaced licensing deal activity
every year over the past three years (see Figure 2).
Royalty monetizations in particular have risen sharply
in both volume and value with the sector experiencing
a 40 percent CAGR (cumulative annual growth rate)
from 2001 through 2012.1
However, the partnering landscape has become
more pressured, competitive and complex in
terms of deal structure. Life sciences licensing
professionals have learned to value, price, and craft
Building a Valuable Agreement
Figure 1. Biopharmaceutical Licenses Signed—Last Twenty Years
3,000
2784
2545
# Transactions Signed
2,500
2329 2321 2389
2010 2152
2,000
1983
1850
2025
1950
1821
1786
1489
1,500
1387
1214 1225
1,000
541
643
837
947
500
2011
2012
2010
2009
2008
2007
2006
2005
2003
2004
2002
2001
2000
1999
1997
1. HealthCare Royalty Partners.
1998
1995
1996
1994
1992
1993
0
Flexibility to Share
Information
Biopharmaceutical license agreements are
increasingly being used to
support financing transactions. While confidentiality provisions are standard
and customary parts of the
agreement, both parties
should have the right to
share critical pieces of the
agreement under confidentiality, with a potential
acquirer or investor. This
may include license terms,
royalty and audit reports.
Each is used to assess the
underlying value of the
March 2014
45
to the licensor, listed by category;
• Calculations for any applicable currency conversions;
• A model royalty report (as an appendix
or attachment).
46
les Nouvelles
2012
2011
2009
2010
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1992
1993
# Transactions Signed
Access to Critical
Figure 2. Biopharmaceutical Deals By Type—Last Twenty Years
Pieces of Information
A license for commer3,000
cialized technology is
one of a licensor’s most
2,500
important assets. But
without access to key
2,000
pieces of information
during the development
1,500
and commercial stages
it is difficult to monitor
1,000
and ultimately value the
license. In the develop500
ment stage, it is important not only to be able
0
to validate how things
are progressing but, at
the most basic level, that
M & As
Asset Purchases
Licenses
Other
the product is actually
being developed. Once
Clarity of Payment Terms & Obligations
the product is on the market, a licensor should be
Uncertainty reduces the value of any asset. It’s the
able to validate the calculation of the royalty rate and
“ifs, ands or buts” in license agreements that make it
estimated payments. Royalty reports by product and
hard to decipher how much money is due and when;
geography; audit rights (before and after the first
what seems clear to those who hammer out the deal
commercial sale) and reports; regulatory informacan often be confusing years later. At a minimum, the
tion (annual report, 10-K, 10-Q); and license comlicense should clearly specify the royalty rate (includmunications will give a licensor the tools to do this
ing what products are covered by the licensed patent
and are indispensable parts of a well-crafted license
agreement.
rights), how it is calculated, when it will be paid and
for how long. Clarity is critical when assessing how
For each licensed product, the reports should
much the asset is worth.
include:
• The number of licensed products
The royalty base definition should anticipate
constituting sales;
different, relevant situations including:
• Gross consideration invoiced, billed,
• Trade channels (i.e. will the licensee sell or received for sales;
directly, through distributors, and/or
• Qualifying costs, listed by category of
trading companies and how will royalties
cost, for the calculation of gross to net sales;
be calculated);
• Net sales;
• Product distribution schemes, including
• Gross amount of any payments and other dosage vs. bulk form;
consideration received by the licensee
• Less than arm’s length transactions;
from sublicensees and the amount of any • Bundled products (i.e. licensed product
allowable deductions permitted under
with other products);
the license in terms of sublicense revenue • Combination products with multiple
sharing;
active ingredients.
• Royalties, fees, and other payments owed
Royalty Term: It is important to look at not only
the patents to be licensed, but the underlying value
of what is being transferred as part of the agreement.
Leaving the know-how or other components unaccounted for can leave the innovator empty handed
after delivering significant value. Historically, a
customary and standard royalty term was “last to
expire” of the patent rights. However, in the world
of generic competition and biosimilars, it may be
no longer appropriate, reasonable, or necessary
for licensors to limit the royalty term to the last to
expire of the licensed patent rights.
Take for example a license that ties specifically to
one cell line. The licensee ultimately changes cell
lines but still uses the additional art and know-how
transferred as part of the deal. Unless the license
requires payment for the “know–how,” the licensor
will receive no royalties. By defining the components
of the value as broadly as possible, a licensor can
maximize the long-term value of the asset.
Royalty Stacking: To preserve the long-term
value of the license, licensors should avoid royalty
stacking or bundled discounts. The royalty rate (and
base) should be a unit or percentage of net sales. If
royalty reductions and other discounts are essential,
an absolute floor or minimum royalty rate should
be specified in the agreement. If the royalty rate
was initially set based on the perceived need for
additional licenses, stacking language can be incorporated to account for the change. For example, the
stacking royalty can be structured to not start until a
defined number of additional licenses are executed
and paid. The agreement should state that there
are no stacking penalties when additional licenses
come from affiliates of the licensee or where cross
licensing is used. Stacking provisions should also
exclude third party licenses that have already been
taken by the licensee.
Sublicense Revenue Sharing: License agreements will regularly delineate payments from sublicensees that are considered gross sublicensing
revenues (“GSR”). However, there is no customary
or standard language for GSR sharing obligations or
a set of generally agreed to deductions or exemptions for GSR. This makes it difficult for a licensor
to define and justify their valuation expectations
for sublicense revenue sharing. Licensors of embryonic technology for example are now allowing for
decreased tiers or ratchets of GSR based on how
much the licensee has contributed to the value of
the product since the agreement was signed. This
helps specify and use development milestones
and diligence obligations as the basis for tiered or
ratchet reductions of the shared GSR percentage in
the agreement.
Standard categories of payments that are
excluded and/or deducted from GSR, and not
eligible for sharing include:
• Royalties paid to licensee, if licensee is obligated to pay licensor a royalty directly (pass-through);
• Amount received to fund or reimburse licensee’s prospective (future) R&D
activities;
• Amount received by licensee to fund
prospective (future) R&D activities by
licensor;
• Amount received for the manufacture and supply of licensed products including
licensed products for clinical trials;
• Equity investments in the licensee by a
sub-licensee up to the amount of the fair market value of the equity purchased on
the date of the investment;
• Loan proceeds paid to the licensee by
a sub-licensee in an arm’s length, full
recourse debt financing, to the extent
that such loan is not forgiven.
Reversion/Termination Rights: While every license agreement is drafted when the parties expect
success, a licensor should negotiate a reciprocal
right to terminate under certain adverse conditions, including conditions of significant product
underperformance. It is also essential to regain
all of the rights owned prior to the agreement,
such as ownership of the intellectual property,
data generated by the licensee (and its affiliates
and sublicensees) and regulatory approvals, upon
termination of the license.
If the intellectual property is sublicensed or may
be sublicensed in the future, the agreement should
specify the sublicensees’ rights in the event of termination. This can be accomplished in a few ways.
The licensees’ rights to the intellectual property can
be granted to the sublicensees or the sublicensees
can be provided preferential rights to access the
licensed patent rights. As simple example, a licensee
is paying a 3 percent royalty and the sublicensee a
6 percent royalty on net sales of the intellectual
property. Assignment of the sublicense to the licensor would net the licensor twice the royalty rate on
the intellectual property over an assignment of the
license to the sublicensee.
March 2014
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Protection of the Intellectual Property
Bankruptcy protection clauses are a critical component of a license agreement. Product liability claims
and unanticipated changes in the market can prompt
bankruptcy reorganization but the stakes change
depending on which party files. Several potential
scenarios should be addressed in the license agreement including:
The Licensor Goes Bankrupt
A licensee will typically want the license to continue even if the licensor goes bankrupt. Licensees
are generally protected in this scenario assuming
there are no anti-assignment right provisions in the
agreement on the part of the licensor. They can elect
to retain their license rights even if the contract is
rejected in bankruptcy court. However, this protection is not available under foreign bankruptcy laws. If
the licensor is a non-U.S. entity, the licensee should
have the right to terminate either for cause or for the
licensor’s bankruptcy. The parties should also mutually agree that the intellectual property is subject to
Section 365(n) of the Bankruptcy Code.
The Licensee Goes Bankrupt
Patent license agreements are not typically assumed
or assigned by a trustee unless the patent owner gives
permission. If the licensor’s objective is to retain
control of the intellectual property, an assignment
provision should be incorporated into the agreement which states that the licensee cannot assign
the agreement without approval from the licensor.
This approval can be qualified with specific language
(i.e. will not be unreasonably withheld, delayed, or
conditioned). The provision can also specify that
the licensee is unable to assign the agreement to a
competitor of the licensor.
The Licensee Becomes Insolvent
A licensor with a potentially bankrupt licensee
may want or need to terminate the license agreement if the licensee becomes insolvent. But with no
effective “ipso facto” clause, a licensor must rely on
other contractual methods to terminate the license
agreement prior to bankruptcy. For example, the
licensor may be able to terminate the agreement if
the licensee pledges its assets used for performance
under the agreement; but, only for the benefit of
creditors, fails to make timely payments under the
agreement, or takes actions that may indicate impending financial difficulty.
Other Legal Considerations
Security Interests
Licensors and licensees can further protect their
48
les Nouvelles
intellectual property by using security interests. A
security interest can be crafted to include rights
that arise under a license agreement including the
right to exploit the intellectual property without
liability for infringement. For example, a licensor
can take a security interest in a license agreement
and the proceeds to secure the licensor’s interest
in the licensee’s performance. A licensee can also
take a security interest in the licensed patents to
secure their right to practice under the patents
without infringement.
While a security interest will not guarantee ownership of the intellectual property upon bankruptcy, it
may place the party ahead of unsecured creditors.
It may also prevent a trustee from assuming and assigning the license to a third party. A licensee with a
security interest in the licensed patents may be able
to acquire the patents instead of electing to continue
under the license.
Ownership Interests and Enforcement Rights
For not-for-profit research institutions in particular,
there are two additional legal considerations that
must be considered: perfecting their ownership rights
in inventions; and structuring agreements in a manner
that is consistent with their enforcement activities.
The U.S. Supreme Court recently reminded us
that patent ownership vests with inventors.2 Not-forprofit research institutions require (by policy and/or
contract) that faculty and staff assign work-related
inventions to the institution. But affirmative steps
are necessary to ensure that all inventors assign
their patent rights to their institutional employers
at the time they make and disclose their inventions.
In cases where investigators are from different
laboratories or institutions, not-for-profits may need
to take additional action to ensure all inventors affirmatively assign.
Patent enforcement activities vary by institution.
Some institutions are directly involved with licensees
in times of enforcement litigation while others are
involved to the extent required by licensees and the
courts. However, even licensors who have assigned
all their substantial rights to the licensee, may be
required to participate in the litigation process.
For further protection, licensors can add in patent
enforcement clauses including no right to sue or
enforce; ability to enforce depending on actions of
exclusive licensees; obligation to join litigation if
exclusive licensees seek to enforce; and sole right
to enforce.
2. Stanford Junior Univ. v. Roche Molecular Sys., 131 S. Ct.
2188, 2195 (2011)
Conclusion
Dealmaking is an essential element of the biopharmaceutical business model and licensing is critical to
product development. The baseline economic terms
in these agreements are important in terms of measuring and realizing the value of intellectual property,
but it is in negotiating the numerous key terms of the
agreement that the full range of value, such as the
“know-how” value of the intellectual property, can be
exploited. Experience has shown that clarity and at-
tention to licensing terms will ease the due diligence
process and simplify future transactions but, most
importantly, preserve the intended value of the deal
in the myriad circumstances that will inevitably occur
following the execution of the agreement. The time
to optimize a license agreement is prior to signing,
when the only certainty is the inability to predict
the future. Attention to these key terms will reduce
restrictions on the ability to respond to adverse situations, and will help a licensor better navigate the
uncharted waters ahead. ■
March 2014
49
Semiconductor IP Deals
What’s Happening With Semiconductor
IP Deals?
By David R. Jarczyk*
On November 19, 2013, David Jarczyk presented
his study of trends in the semiconductor industry to
the LES (USA & Canada) Semiconductor Committee
entitled, Perspectives on Market and Pricing Dynamics in Semiconductor Licensing. This is a summary of
the presentation.
or the purpose of this study, licensing and
patenting information in the semiconductor
industry was studied with the goal of identifying key trends within the industry. The study analyzed
executed licensing deals as well as published patent
information. Specific attention was paid to the types
of IP licensed, royalty/payment structures, exclusivity,
territory, and sublicensing, as well as the purchase/
sale of patents.
Information was derived from ktMINE’s repository
of over 100,000 license agreements, nearly 60,000
royalty rate structures, and over 15 million patents
and patent assignments. The information was then organized and analyzed to uncover the following trends.1
F
Most Active Companies—Licensing
When looking at the licensing activity in the
semiconductor industry over the past 12 years, the
following companies had the highest level of activity.
Activity is defined as entering into a license agreement as a filer, licensor, licensee, or a combination
of the three.
1. Chartered Semiconductor Manufacturing Ltd.
2. Advanced Micro Devices Inc.
3. Tessera Technologies Inc.
4. Jazz Semiconductors Inc.
5. Rambus Inc.
6. Micron Technology Inc.
7. Nanosys Inc.
*The author thanks John Wiora and Danielle Lambert for
their contributions to this study and article.
50
les Nouvelles
Most Active Companies—Patent
Assignments
When reviewing patent activity—specifically the
purchase/sale of a patent or patent portfolio—in the
semiconductor industry, the following companies had
the highest level of activity. Activity is calculated by
the number of patent assignments in and out.
Top Assignees (assignments in)
1. Semiconductor Energy Laboratory Co. Ltd.
2. Hynix Semiconductor Inc.
3. Freescale Semiconductor Inc.
4. Samsung Electronics Co. Ltd.
5. Pegre Semiconductors
6. Intellectual Ventures LLC
7. Nippon Steel Corporation
8. Peere Semiconductors
Top Assignors (assignments out)
1. Freescale Semiconductor Inc.
2. Yamazaki Shunpei
3. Nippon Steel Corporation
4. Pegre Semiconductors LLC
5. NS Solutions Corporation
6. Hazama Katsuki
7. Kato Kiyoshi
8. Samsung LED Co. Ltd.
Top Industries of Exploitation
It is well known that semiconductors and its technology are utilized in numerous industries, with
numerous applications. Based on the data analyzed
for this study, the following industries represent the
highest level of applicable activity outside of Semiconductors.
1. Computer Hardware and Software
2. Telecommunications
3. Consumer Durables
4. Industrial Equipment and Machinery
5. Transportation Equipment and Parts
Type of IP Licensed
For this study, the analyzed IP deals were classified into one of three categories: manufacturing
intangibles, marketing intangibles, or combination
intangibles. Manufacturing intangibles involve
the right to use any combination of patents, processes, know-how, technical information, recipes,
formulations and manufacturing training materials.
Marketing intangibles include the right to use any
combination of trademarks, trade names, trade
dress, copyrights, service marks, and logos. When
both manufacturing and marketing intangibles are
licensed as part of the same transaction, combination intangible is designated.
A review of executed licensing deals in the semiconductor industry shows a trend to license-out
manufacturing intangibles over marketing intangibles.
Based on the analysis, 72 percent of IP deals licensed
the right to manufacturing intangibles, while less than
3 percent of IP deals licensed the right to marketing
intangibles. Approximately 24 percent of IP deals
licensed the right to both marketing and manufacturing intangibles.
Figure 1. Agreement Type
Manufacturing
Intangibles
24.6%
Marketing
Intangibles
Combo
Intangibles
2.4%
72.0%
Exclusivity
The analyzed IP deals were classified into one
of four categories: exclusive, non-exclusive, multiexclusive, or N/A. Exclusive deals provide sole
rights to the licensed IP to the licensee while nonexclusive deals allow the IP owner to enter into
numerous licensing deals related to the licensed IP.
Multi-exclusive deals have both exclusive terms and
non-exclusive terms. For example, a multi-exclusive
deal may grant the right to utilize the licensed IP
in one field of use exclusively and in all other fields
of use non-exclusively. N/A signifies exclusivity was
not specified within the agreement.
When manufacturing intangibles were licensed,
63 percent of agreements provided for both exclusive rights in a specific field, market or territory as
well as non-exclusive rights in non-primary fields,
markets or territories. However, only 20 percent
of manufacturing intangibles were licensed exclusively, and just over 11 percent were licensed nonexclusively. Just over 5 percent of IP deals did not
provide exclusivity language.
When marketing intangibles were licensed,
100 percent of IP deals
analyzed provided for
■ David R. Jarczyk,
multi-exclusive terms.
ktMINE,
Exclusivity was granted
President & CEO,
to a particular field of
use or territory, whereChicago, IL, USA
as the licenses were
E-mail: david.jarczyk@
non-exclusive for all
ktmine.com
unlisted fields of use
and territories.
When both manufacturing and marketing intangibles were licensed, over 93 percent of IP deals
provided for multi-exclusive terms and 6 percent of
IP deals did not provide exclusivity language.
Royalty Bases
An integral aspect of IP valuation is determining
the royalty bases associated with the license of IP.
For this study, the royalty bases from each agreement
were analyzed and, where necessary, normalized to
conventional accounting definitions of gross sales,
net sales, costs, gross profit, operating profit, and
net profit.
When manufacturing intangibles were licensed,
over 50 percent of IP deals favored a payment structure based on net sales. Over 31 percent of IP deals
called for a payment based on number of units sold.
There was also evidence of payments made on gross
sales and net profits.
When marketing intangibles were licensed, 100 percent of IP deals called for payments made on net sales.
When both manufacturing and marketing intangibles were licensed, 32 percent of IP deals required
a payment structure based on net sales, followed by
almost 30 percent of payments made on gross sales.
There was also evidence of payments made on gross
profit and units sold.
Territory
The territory of an IP deal refers to the geographic
location(s) the licensee may exploit the licensed
rights. Over 66 percent of IP deals allowed for worldMarch 2014
51
Figure 2. Exclusivity
Total
4%
Marketing Intangibles
Manufacturing Intangibles
16%
Combination Intangibles
6.3%
5.6%
100%
20%
8%
11.1%
72%
93.8%
63.3%
Non-Exclusive
Exclusive
Multi-Exclusive
N/A
Figure 3. Royalty Payments
Marketing Intangibles
Manufacturing Intangibles
14.6%
31.1%
Combination Intangibles
8.8%
100%
29.4%
Gross Sales
Net Sales
Costs
23.5%
Gross Profit
Operating Profit
1%
1%
Net Profit
5.9%
32.4%
52.4%
wide exploitation. Exploiting rights in North America,
Asia, Europe, and South America, respectively, represented 14.5 percent, 11 percent, 6 percent, and
2.1 percent of analyzed deals.
Figure 4. Territory
Assets
Per Unit
Sublicensing
IP deals for manufacturing intangibles typically
specified sublicensing rights. In these cases, all payments were made on net sales. ■
Figure 5. Sublicensing
2.1%
100%
14.5%
Worldwide
6%
Asia
Manufacturing
Intangibles
Europe
Marketing
Intangibles
North America
South America
11%
66.2%
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les Nouvelles
Combo
Intangibles
Factors In Early Stage Software
Valuation Discussion Factors In Early
Stage Software
By Dwight Olson*
This article will review factors that help contribute in
early stage software valuation discussions. For example,
pre-investment money discussions and pre-money scenarios typically center on investors prior investment
deals. For example, what equity did they get for what
investment. This, in some way, establishes the value of
the early stage software and company, but what factors
might change this scenario for our future? History has
shown that value of early stage software increases as
market, technological and financial feasibility factors
valorize.1 As LES members, we know that intellectual
property and freedom to operate factors also contribute. Monetary forecasting (probability) really begins
to take shape when management has obtained the
resources or investments to produce and sales of the
software product begins. Some of these factors have
become so established that the U.S. Federal Accounting Standards Board (FASB) adopted them. These are
not monetary or earnings factors, they are factors that
reveal the inherent value of early stage technology;
here our focus is early stage software.
The Factors:
•The technological factor
•The management commitment factor
•The market factor
•The financial feasibility factor
•The IP factors
This is hopefully the first of many articles discussing quality factors of early stage technology valuation/
evaluation issues. This article is not on patent quality,2
but a discussion of the technology itself as it morphs
from idea to collateral. So, we start to address early
stage technology value factors with this article using software as one industry example, of hopefully
many; we must ask ourselves, how does one begin
to value “Early Stage Technology”? And, we will also
limit our discussion to software that is bound for
commercialization that is a product as an end goal.
*Many thanks to the LESI IP Valuation Committee and other
LES members for their valuable thoughts and contributions to
this article.
1. The EU Leonardo programme defines “valorisation” as “...
the process of disseminating and exploiting project outcomes to
meet user needs.”
2. A good reference for patent beginners is “True Patent Value Defining Quality in Patents and Patent Portfolios,” 2013, by
Larry M Goldstein.
Some LES members feel that if we can describe the
issues for one industry, some may also be appropriate
for other industries.
We start with Bill Elkington, an LES member in the
automotive area, who states in his 2013 IAM article
that software permeates everything.
“This software-created revolution in the economic power of the
individual is matched
by what software is be■ Dwight Olson,
ing made to do for the
V3Data, Principal,
corporation. CompaSan Diego, CA, USA
nies’ competitiveness
Chair, LESI IP Valuation
has been transformed
Committee
through the use of
software frameworks;
software modelling,
development, and test
tools; business models built on providing software rather than hardware products, providing
software as a service, or providing information
through software applications; software systems
that manage many of the enterprise’s operations
processes; software collaboration tools that effectively integrate the work of global design and
development teams; and so forth.
Marc Andreessen is right: software is eating our
traditional businesses, in addition to creating
whole new businesses. It is the locus of contemporary capitalism’s “Creative Destruction,” a term
coined by Joseph Schumpter, which was inspired
by Schumpter’s reading of Karl Marx. It is how
the corporation is innovating how it does business
and how it innovates what it is in business to do.
In product company after product company,
the value of the product is in the software
that is at its heart. In company after company,
application-specific integrated circuits are being morphed into software that runs on general
purpose processors. In company after company,
technology trends and market forces are forcing
the product software to be abstracted from the
company’s product hardware. The hardware,
for the most part, in embedded products is being commoditised. The differentiation is in the
software. Thus, the computer has become a tool
March 2014
53
for our imagination, with software the language
of our imagination.
The automobile industry is a good example of
some of these trends. One reads that 40 percent
of the value of a new car today is in its electronic
systems. One reads that a typical car has 40 to 50
controllers and microprocessors, and that luxury
models contain double this number. One reads that
a typical new car today runs about 10 million lines
of code, with projections as high as 30 times that
number in about 10 years, to accommodate the
greater and greater automation of the car’s various
systems, reaching substantially into the complete
operation of the automobile itself—the “driver-less
car” that Google and others are promoting.”
In the early to mid-1980s in the United States,
software vendors wanted to capitalize their development costs and expense those costs against future
revenue, but first they needed to get approval from
the U.S.’ Federal Accounting Standards Board (FASB)
and the American Institute of Certified Public Accountants (AICPA). We know that they were successful in
setting the first standard of financial accounting in
“reporting for the costs of computer software to be
old, leased, used, or otherwise marketed; whether
internally developed and produced or purchased”
and getting software considered as a financial asset.
From FASB 86 (USA)
In February 1984, the FASB3 received an Issues
Paper, “Accounting for Costs of Software for Sale
or Lease,” prepared by the AICPA Accounting Standards Division’s Task Force on Accounting for the
Development and Sale of Computer Software and
approved by its Accounting Standards Executive
Committee. The task force included members of
ADAPSO—The Computer Software and Services
Industry Association (formerly known as the Association of Data Processing Service Organizations)
and the National Association of Accountants. That
Issues Paper recommended that certain costs incurred in creating computer software for sale or
lease be recorded as an asset. Subsequently, the
Board expanded the scope of its project to encompass purchased software that is to be sold, leased,
3. The Financial Accounting Standards Board (FASB) is a private, not-for-profit organization whose primary purpose is to develop generally accepted accounting principles (GAAP) within
the United States in the public’s interest. The Securities and
Exchange Commission (SEC) designated the FASB as the organization responsible for setting accounting standards for public
companies in the U.S. Wikipedia, 2013.
54
les Nouvelles
or otherwise marketed and reached somewhat
different conclusions from the recommendations
in the Issues Paper. On August 31, 1984, the Board
issued an Exposure Draft of a proposed Statement
on the accounting for the costs of computer software to be sold, leased, or otherwise marketed as
a separate product or as part of a product or process. That Exposure Draft proposed that the costs
incurred internally in creating a computer software
product would be charged to expense until cost
recoverability had been established by determining
market, technological, and financial feasibility
for the product and management had or could
obtain the resources to produce and market
the product and was committed to doing so.
Thereafter, the costs of the detail program design
would have been charged to expense, and the
costs of producing the product masters, including
coding and testing, would have been capitalized.
The capitalized costs would have been reviewed
periodically for recoverability. All costs of planning,
designing, and establishing the technological feasibility of a computer software product would have
been research and development costs.
We may take another step in adding to this list,
for example, those of us who are in the IP licensing
business know that the following IP factors should
also be considered:
• work for hire assignments,
• freedom to commercialize,
• intellectual property protections, and
• rights considerations.
Technology Feasibility
If we look at the final statement from FASB 86 on
software:
This Statement specifies that costs incurred internally in creating a computer software product shall
be charged to expense when incurred as research
and development until technological feasibility has
been established for the product. Technological
feasibility is established upon completion of
a detail program design or, in its absence,
completion of a working model.
For purposes of this Statement, the technological
feasibility of a computer software product is established when the enterprise has completed all planning, designing, coding, and testing activities that
are necessary to establish that the product can be
produced to meet its design specifications including functions, features, and technical performance
requirements.
As a side note, those of us as LES licensing professionals know that an important part of the patent
process is the “Reduction to Practice” or just another
way of saying technology feasibility. The reduction
to practice is a concept meaning the embodiment
of the concept of an invention and the embodiment
of an invention can either be:
• Actual reduction to practice
• Constructive reduction to practice
• Simultaneous conception and reduction
to practice4
This perspective on technology feasibility gives
us some basis of value especially for folks who wish
to “commercialize” early stage technology. We state
that technology that has a working model “has more
value than technology that does not have a working model.” This may be intuitive, but important to
state. FASB listed this as the number one factor in its
requirement for software.
And we would assume that a patent or patent application embodying or relating to the technology would
potentially increase the commercial or desirability
of the technology by an entity. That is assuming the
patent is good and the claims embody the technology.
Management Commitment
In consideration of software as a capital asset, FASB
considered management commitment an important
requirement. “Exposure Draft proposed that the costs
incurred internally in creating a computer software
product would be charged to expense until cost recoverability had been established by determining market,
technological, and financial feasibility for the product
and management had or could obtain the resources to
produce and market the product and was committed to
doing so.” One implementation of this management
factor might be the existence or creation of a business
with a “strategic plan” or “business plan” for making
money with the technology. The business plan is the
“rallying cry” of any start-up venture, and should be
for anyone thinking of commercializing early stage
technology. Sound management with a business plan
not only helps raise capital, but it also helps create
enduring value and guidance. The business plan acts
as the operations manual for the technology commercialization and as a reference tool for investors and
management of the technology. It’s therefore very
crucial to think through commercialization and have
a sound business plan with management committed
to making money with the technology.
4. See Wikipedia “reduction to practice.”
In developing the plan one should analyze strengths,
weaknesses, opportunities, and threats. An effective
business plan should:
• Help focus ideas about a market opportunity and how to turn them into a realistic course
of action.
• Create a path to follow in the early years
for commercialization of the technology.
• Identify milestones & benchmarks that can measure progress.
• Be succinct, interesting, and sufficiently solid enough to attract prospective investors,
buyers, or licensees.
• Be thoughtful and flexible enough to handle contingencies and unexpected events.
If one is looking to find an investor or buyer, then
one must keep in mind what an investor or buyer is
looking for:
1.A specific and realistic source of value that
differentially fulfills a specific and unmet need.
2.A team that can plan and execute the plan
with success.
3.Of course, a sustainable and defensible
product/service position.
In some cases of research at the university level, a
strategic plan for some early stage technology patents
might be as simple as finding someone who wants to
“monetize” the technology and license or sell them
the patents. But, typically for early stage software
based technology, patents may or may not exist, and
you will need to find someone who wants to invest
in commercialization. If such is the case, then a business plan must be in order and will provide value. The
“value” of the plan will be evaluated by investors for
soundness and appropriateness. They will, of course,
focus on the financial feasibility, but the financial
feasibility will only be as good as the plan.
Market Feasibility
...the major cause of failure of any innovation relates to market analysis. The truth about
innovation is that most ideas or inventions never get
commercialized. It has been estimated that only about
5 percent of the active patents are being commercially
utilized. Some studies have also shown that only one
idea is commercialized out of 1,000 new product ideas
generated and that only 1 in 4 products in development
get commercialized. Why are there so many failures?
Robert Cooper, a pioneer in new product development processes, investigated the cause of failure of
new ideas at many companies. He concluded that
the major cause of failure relates to market analysis.
March 2014
55
That is, the companies did not understand their target
markets well enough to know how to market properly
or whether they should even have been committed to
the commercialization at all.5
In FASB 86 for software capitalization, the issue
of new versus update of an existing product is an
important factor to consider. “The translation of
research findings or other knowledge into a plan
or design for a new product or process or for a
significant improvement to an existing product
or process whether intended for sale or use. It
includes the conceptual formulation, design,
and testing of product alternatives, construction
of prototypes, and operation of pilot plants. It
does not include routine or periodic alterations
to existing products, production lines, manufacturing processes, and other ongoing operations
even though those alterations may represent
improvements and it does not include market
research or market testing activities.”
Sections of the business plan should address market feasibility, why someone would buy the product.
Some factors involved in market analysis and planning
take into account the market size and growth, today
and in the future. It will be important to know target
customers and ways in which to capitalize on them in
order to bring profitability and sustainability.
If the ultimate product or service is new, market
research probably will be required to put meaningful
dimensions on the initial business plan and market. If
the product or service represents an improvement on
what is available, there may already be well-defined
dimensions to the market. In market feasibility it is
important to show historical data and reliable forecasts from industry, trade associations or government
sources that detail:
1.Who are the customers?
2.What is the historic and predicted rate of growth for each market segment?
3.Where are the present and future markets?
Are they regional, national, or international?
4.How does each market segment purchase
the product?
5.What are the critical product/service
characteristics?
6.Consider performance, reliability, durability, availability, price and service.
5. Dave Braunstein and Larry Plonsker, The Licensing Decision, Licensing Executives Society (USA & Canada), U. S. Department of Energy, Inventions and Innovations Program.
56
les Nouvelles
7. What substitutes are available for this product?
8. Does the market have any special characteristics, such as seasonal factor?
Other items to consider in the market feasibility
factor are:
The Competition
If the technology is new, you may likely face entrenched competition from mature organizations
with far greater resources. Identify competitors
in the business plan and note the strengths,
weaknesses and market share of each. Be realistic
about the analysis and address all the negatives
to show that commercialization is possible. The
business plan should also indicate the market
share you expect to capture in the first three
to five years. Cite the principal competitive factors in the marketplace: product performance,
reliability, durability, styling, delivery, service,
aggressive merchandising, price, and other factors. Identify trends and explain how you plan
to react to them. A prospective investor will
also want to know how competitors are likely
to react to entry into the market and how you
plan to respond. Perhaps the greatest temptation
will be to overstate the technology strengths and
understate competitors’ skills.
Marketing
Marketing is a crucial element of a business plan,
and its importance is often underestimated. It
defines strategy and charts the marketing direction for the staff. This section of the business
plan should give prospective investors or buyers
confidence that one could convert the technology
into a brand and marketing position. Investors or
buyers want reassurance that the technology could
generate a growing profit stream. The marketing
section of the business plan normally sets the stage
for, or summarizes, a more detailed marketing
plan. When the time is right—either at startup or
at some future stage—a marketing executive will
need to develop a comprehensive marketing plan
to guide that critical function on both an annual
and a long-term basis. Regardless of whether the
company is in the research or development stage
or ready to take products to market, summarize the
marketing goals. These goals should be quantitative, realistic and consistent with the marketing
analysis. They should also address the consistently
and rapidly changing markets of the new economy.
Pricing Strategy
One must decide how to price the technology’s
product compared to the competition. One must
also be able to support that price by identifying
ways in which your venture adds to the value of
the item if there are readily available substitutes
for your product. Keep in mind the product’s current and projected product life cycle stages, how
pricing will change at different times, and how
competition might react under those conditions.
Sales
The marketing plan should address strategy for
building sales and therefore revenues. These plans
should be consistent with both market data and
financial projections. Advertising on the Internet,
email campaigns, as well as traditional media such
as television commercials, must all come under
consideration. The market must be aware of the
brand and want to choose the product, given that
there is a need for your market offering. One
must also decide how much of the promotion
will be handled internally and how much will be
outsourced. If an advertising or public relations
agency is chosen, prospective investors will want
to know which one.
Financial Feasibility
The FASB 86 Software Exposure Draft proposed
that the costs incurred internally in creating a computer software product would be charged to expense
until cost recoverability had been established by
determining … financial feasibility for the product.
Simply put, the product will make money.
The financial feasibility study will be the most
difficult for nearly anyone including University Tech
Transfer professionals. In some ways this will be the
gem for the technology and may be the only factor
considered by an investor. The forecasting of potential
revenues, expenses and profits is not the easiest of
tasks. A financial plan should contain a discussion of
the costs, revenue and potential earnings that might
be associated with the product or service put into
commercialization. It is sometimes very easy to associate a market share or royalty rate with an existing
market share. For example, in pharmaceuticals there
is a lot of data available about sales from the date
of introduction showing how quickly a drug can be
ramped up and where it peaks. So if you have a new
drug in a similar category and it has an advantage,
like elimination of a side effect, there is guidance for
forecasting the new and better drug.
Data also can be found for blockbuster add-on
products like cell phones, DVDs, and other associated
products showing where there might be a rapid climb
in sales. But what about some university that invents
some sort of new and fantastic glue or toy helicopter
or shoe insert or nitrogen filled window panes that
improve insulation? This is where the difficult path
will be. Many of us do not know where to even begin.
Maybe a look at what an LES member who has written
about early stage valuation of IP, Raz Razgaitis, might
also be helpful in just looking at the technology itself.
The value of a technology to a buyer (licensee) depends upon how it is to be commercially employed,
taking into account the cost of development, the
time the technology takes to generate returns,
the extent of such financial returns, and the risk
involved in the process. At the time of a licensing/
sale transaction of an early-stage technology many,
perhaps all, of such factors need to be assessed and
quantified by making judgments about how the
future will unfold with respect to the technology
being developed. This assessment and forecast assessment are the essence of all pro forma business
models. Valuing license rights for early-stage technologies is in this sense no different than making
other future business forecasts, though the details
may differ because the forecast time horizon may
be longer, the uncertainties may be greater as to
the market size and profitability, the operating
performance of the technology as it will be used
in commercial operation may be less well defined,
and other factors. The price paid for a technology transferred between parties is the amount of
money (present and future) and/or the financial
value of noncash assets given in exchange for the
transfer of the technology, which can only occur
if both the seller (licensor) and buyer (licensee)
have by some process reached a common, present
understanding of value that makes agreement possible…. The price can consist of any combination
of a variety of types of consideration, including
running royalties, fixed payments, common stock
(equity), R&D funding, lab equipment, consulting
services, grant backs, or access to other proprietary
buyer resources.”6
As Raz states, “A key consideration in valuing a
technology and arriving at a price is determining
what is to be provided or transferred between the
parties.” In licensing software, this may include exclusive or nonexclusive rights to specified know-how,
copyrights, patents, technical data, rights to future
improvements, rights to sublicense, installation if
needed, user documentation, support for problems
and bug fixes, future updates and the like.
6. Pricing the Intellectual Property of Early-Stage Technologies: A Primer of Basic Valuation Tools and Considerations, Richard Razgaitis , Senior Advisor, CRA International, Inc., U.S.A.
March 2014
57
IP Factors to Consider
Those of us who are in the IP licensing business
know that ownership, freedom to commercialize, and
intellectual property rights homework needs to also
be considered. These include items such as copyright
and patent assignments to uncovering prior development license encumbrances. Doing IP homework also
means understanding the literature in the area of the
idea or invention. Before filing for patent protection,
if you have made that decision, a comprehensive
literature search needs to be carried out on a global
basis to identify any other prior art, or published information related to your area of interest. This search
will also help you out when you prepare the initial
market and business plan for the commercialization
and monetization process. And, in many countries,
should a patent be considered, all relevant prior art
must be submitted to the patent office when you
apply for patent protection. Your search for both the
market information, related technology and patents
will reveal which companies are active in the area of
your invention. This is particularly important since
this identifies potential licensees and competition. It
also represents companies or individuals to contact to
get information about the markets of interest. A final
point on doing your homework is that the telephone
is still a useful and efficient way to get information.
Good market information can be obtained by simply
asking the right question.
Many of us at LES believe that we are at the beginning of an era that considers wealth of technology
assets to be of importance to governments, organization, and the global public. If so, then accurately
identifying, analyzing, valuing, and evaluating the
technology and corresponding assets must be addressed as an important part of the infrastructure
for early stage technology commercialization. We on
the LESI IP Valuation Committee also believe that the
IP Valuation Primer (available at the LESI Valuation
Committee website) provides a basis for understanding and valuing IP “in the marketplace.” Maybe too,
we need to expand our LES mantra of “Wealth in
the 21st Century will be measured by IP” to “Global
wealth in the 21st Century will be measured in the
ownership, licensing, commercialization and management of intellectual assets and property including
early stage technology.”
So in closing of this article, I will leave you with
two thoughts: the first is in the book “Valuing Your
Business For An Investor”-—2002 by D.W.Berkus:
“There is an eleventh method—but it is one I use
only as a rule of thumb to size up the first ten. For
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les Nouvelles
early stage companies, I use the “Berkus Method”
approach. I give $500,000 valuation credit for the
attractiveness of the core idea upon which the company is founded (assuming that I am attracted to it).
I add another $500,000 if I believe good management is already in place to execute to the plan in the
early stages of rapid growth. Then I add $500,000
if the company has struck impressive strategic alliances with either vendors or customers, adding to
barriers of entry for other businesses. Finally I add
$500,000 if the company has completed its product
or prototype and demonstrated its attractiveness
before an appreciative customer candidate, which
all goes to further reduce the risk of investment,
adding to value.”
The last is from a book by John Ramsay, a close
friend, “There is no one “right way” to value technology. … Whatever the purpose, the valuation will
involve a risk/benefit assessment by the parties involved. Although evaluation may have objective tools
available …, they will ultimately have to subjectively
assess the importance of the various objective factors
to the party to the transaction performing the valuation.” —Ramsay on Technology Transfer, 3d edition.
The LESI Valuation Committee has been asked to
discuss early stage valuation for technology. It started
when the Valuation Committee contributed to the
first ever IP Valuation Primer7 that was prepared for
the first meeting of the Global Technology Impact Forum (GTIF) sponsored by LESI and WIPO in Geneva,
Switzerland, January 2012. After the primer release
at the GTIF, we received many comments from both
WIPO and LESI University Tech Transfer professionals that the primer was good, but it did not address
the need to “understand” the “value” principles in
early stage technology. That is, the primer is useful
for existing and established Intellectual Property (IP),
but not for valuing in early stage technology. The comments to the primer about the valuation basics of IP
were probably right. That is, the IP we discussed in
the primer (patents, trademarks, and copyright) were
most likely involved in achieving revenue or involved
through infringing products. We believe that the
primer is quite valuable for providing guidance to the
global marketplace on IP valuation basics, but we need
to look more closely at early stage valuation issues
for the international community of LES members. ■
7. GTIF/WIPO IP Valuation Primer, started in 2010 by OceanTomo with help from the IP Valuation Committee and posted to
the LESI website in 2013.
Patent Securitization In Taiwan
Biomedical Patent Securitization In Taiwan
By Mei-Hsin Wang
Abstract
Funding institutions such as Banks are currently hesitant to undertake lending to businesses on the basis of
pledges of intellectual property. This is due to a variety
of factors, such as the difficulty in maintaining the
value of the intellectual property (“IP”), the imperfections in the method of valuing IP, a lack of confidence
in IP, an overestimation of the degree of risk associated
with IP and the inefficiency in realizing on pledged
intellectual property assets. In this article, cases on
intellectual property securitization from around the
world are examined, together with the factors which
make them successful. In addition, issues and suggestions for future legislation are reviewed, as are applications of the current forms of asset securitization
to provide for private fundraising and the commercial
issues that arise after patent securitization legislation
is introduced. Finally, suggestions on biomedical patent
securitization legislation are presented and the properties that intellectual property should possess in order
to be useable as security for fundraising are explained.
The foreign examples of fundraising and lending institutions are presented as demonstrative as to how
the mechanism and framework for implementation of
biomedical patent securitization would operate. It is
hoped this article will contribute to future legislation
on intellectual property securitization, starting with
biomedical patent securitization.
1. History of Patent Securitization
P
atent securitization is a form of intellectual
property-based assets securitization which
started in United States in the 1970s. The
earliest cases of intellectual property securitization
involved copyrights in the musical and digital-rights
fields by entertainers, such as David Bowie, James
Brown, Ashford & Simpson, the Isely Brothers, and
Iron Maiden. Other examples include the Italian film
maker Cecchi Gori (securitization of future movie
income in 1999), fashion designer Bill Blass (trademark securitization) and Formula 1 (securitization of
trademark, copyright and royalties).
The first example of patent securitization is that
which was under written by Royalty Pharma in
2000. The securitized asset was “Zerit,”an anti HIV
medicine that raised 115 million U.S. dollars for Yale
University. In 2003, Royalty Pharma again involved in
an important securitization, this time involving 13
medicines from several companies raising 225 million
U.S. dollars. These two cases reveal the potential of,
and demonstrate the successful models for, biomedical patents securitization.
Patent securitization offers new sources of funding for patented technology while providing tax offset and investment protection. The patent owner
does not need to lose
the whole patent right
■ Mei-Hsin Wang,
or accept unfavorable
IP Property Office,
conditions simply due to
Graduate School of
a lack of funding. Patent
Materials Science,
securitization also offers
National Yunlin University of
the following additional
advantages for the capital
Science and Technology,
markets:
DouLiou City, Taiwan
(1) A new financial
E-mail: maywang3@
product: a new opyuntech.edu.tw
tion for investors to
broaden options for
their investment portfolios.
(2) A simplified asset: investors only need to
focus on the securitized patent, patent pool or
royalty stream; there is less need to worry about
the credit record, financial performance, operation
or management of the IP owner.
(3) An asset with a risk management mechanism: the system provides a vehicle that shields
the IP assets which have been securitized from
the bankruptcy of the IP owner. The securitized
IP is isolated from the owner, and there is a creditenhancement mechanism.
2. Special Characteristics of
Biomedical Patents
Due to profound scientific hurdles and regulatory
requirements of, for example, the U.S. Food and Drug
Administration office and related medicine laws, the
entry barrier into this business is rather high and
the funding required to validate the quality of the
patented technology is much larger than can normally
1. http://www.cpmda.org.tw/file/e_news/037/d/037.pdf,
28 Apr 2012 visited.
March 2014
59
be expected. The application fee alone for U.S. FDA
can cost from 20 to 30 million NT dollars,1 not to
mention the cost and expense of drug discovery, preclinical trials, phase I, II, III a, b, and phase IV trials,
good manufacture practice, good laboratory practice,
etc. In addition the patent securitization process is
a highly complex and technical one, requiring the
parties involved, such as the inventor, the patent
holder, the investor, special purpose vehicle, issuer,
underwriter, buyer, bond holder, etc., to be highly
trained. These reasons all point to the importance of
appropriate statutory mechanisms and government
involvement in the process to provide for protection
for all parties involved.
Unlike other industries, if a patent expires, many
biomedical technologies can still profitably be on the
market for patient use, although the price will drop
to a certain extent. Drugs, such as aspirin, penicillin,
etc., demonstrate that products normally need not
completely disappear from the market, but rather, can
continue to generate relatively steady profits.2 This is
typically achieved, for example, by the use of the drug
for new indications. An example of this is, lamivudine3
which was originally developed for the treatment of
hepatitis B, but which is now also approved for use
in HIV combination treatment. Another example is
Quinine,4 which was originally developed for treating
malaria, but which now is approved for the treatment
of Lupus (systemic Lupus Erythematosus, SLE).5
Biomedical patent securitization is a kind of new investment choice for the general public to participate
in the business of saving lives, but for those parties
involved in the securitization mechanism, it can be
a far more complicated one than exists with other
technologies.
In addition, biomedical patents have relatively
higher development and commercialization costs
than those usually associated with other types of
intellectual property. In order to manage the risks
2. See John S. Hillery, “Securitization of Intellectual Property: Recent Trends from the United States,” Washington Core,
March 2004, p23; www.iip.or.jp/summary/pdf/WCORE2004s.
pdf, 20 June, 2007 visited, at 14.
3. http://en.wikipedia.org/wiki/Lamivudine, 28 Apr 2012 visited.
4. http://zh.wikipedia.org/wiki/ percentE5 percentA5 percent8E percentE5 percentAF percentA7,
28 Apr 2012 visited.
5. http://translate.google.com.tw/translate?hl=zh-TW&sl=
en&tl=zh-TW&u=http percent3A percent2F percent2Fwww.
medicinenet.com percent2Fsystemic_lupus percent2Farticle.
htm&anno=2, 28 Apr 2012 visited.
60
les Nouvelles
and uncertainty, the securitization process must be
carefully and professionally handled to maximize the
commercial benefits that securitization can bring via
such strategies as patent life cycle management and
patent enforcement.
3. Legislation on Biomedical Securitization
in Taiwan
Traditional assets securitization is a creative financial product used to attract investors. Biomedical
patents are intellectual properties that can be securitized for cash flow as long as accounting concerns
relating to the unique features from the intellectual
properties (i.e., the uncertainty of forecasting cash
flow precisely) can be understood and managed.
According to traditional accounting principles, expenses and costs should be able to be listed on the
balance sheet, however, Article 60 of the Taiwanese
Income Tax Act clearly states that “… Business rights,
trademarks, copyrights, patents and other franchises
are assets only if they are acquired by purchase…,”6
meaning that patents developed internally can only
be listed as research expenses and cannot be considered as assets on a company balance sheet, while the
other assets with an objective value can.7 Therefore,
how to amend the traditional accounting principle
for asset definition is certainly one of the directions
for legislation in order to promote biomedical patent
securitization in Taiwan.8
Another area in Taiwanese law that is ripe for
legislation is how to place a financial value on the
intellectual property being securitized. In Taiwan,
the Enforcement Rules of the Estate and Gift Tax Act,
Article 35 states that: “Unless otherwise provided
for under other relevant acts or regulations, for the
valuation of intangible assets, the provisions under
the preceding article [Article 34] shall apply mutatis
mutandis.,” while Article 34 elaborates “The value
of…rights shall be determined according to the years
remaining.
“…For mining and fishing rights, the estate and
gift tax shall be levied only in accordance with
the provisions set forth under the two preceding
6. http://law.moj.gov.tw/Eng/LawClass/LawAll.aspx?PCode=
G0340003, 28 Apr 2012 visited.
7. See Liu C-C, “Accounting Measure on Intangible Assets,”
Security and Future Journal, Vol. 24, No. 12, p4, Dec 2006.
8. See “Accounting Standard Measurement and Principle for
Intangible Assets” in the no. 37, Standard Report for Finance
and Accounting, p4, announced by Taiwan Accounting Research
and Development Foundation on 20 July 20006, based on International Accounting Standard no. 38 (IAS 38), effective from 1
Jan 2007.
paragraphs. The trade name carried on by the
business established thereunder shall no longer
be subject to estate or gift tax payment.”9
Those provisions also provide examples as to
how to calculate the value of the patent rights within
limited periods of time and instruct that intangible
assets shall follow these principles if there are no
other laws or regulations to be followed. In addition,
the ShiZi no 563 comments from Taiwan grand judges
meeting on 28 Dec 2001 on this subject states that:
“…the calculation for the stocks from the non-listed
or over-the-counter companies are involved in the tax
burdens on people, therefore, it shall be legislated
according to the law…,”10 thereby further demonstrating the legislatures power to provide guidance on
asset valuation. These examples can be relied upon
to provide the legislature with a framework by which
it can value intangible assets, like biomedical patents.
4. Parties, Processes and Legal Design Involved in Legislation of Biomedical Patent
Securitization
There are several factors involved in the intellectual
property securitization process, including originators,
the credit enhancement mechanism, credit evaluation
agencies, consulting and investment institutes, security underwriters and agencies, bonds underwriters
and agencies, assets services institutes, and others,
all of whom play their particular role in making the
securitization process a success.
4.1Parties Involved in Legislation of Biomedical
Securitization
Securitization is a process wherein assets are turned
into securities, and relies on the participation of parties with various professions to be successful. Briefly,
the parties involved are:
(1) The Debtor(s)/Borrower(s): the debtor(s) or
borrower(s) apply for the loan from the originator
to generate the creditor’s right. Thereafter, the
debtor/borrower pays the originator principal and
interest based on a cash flow that the patent rights
can be expected to provide.
(2) The Originator: the originator is the owner
of the securitized asset(s). In return for capital, all
or part of the rights from the securitized assets
are transferred to a special purpose vehicle for
initiating and maintaining the securitized intellec-
9. http://law.moj.gov.tw/Eng/LawClass/LawAll.aspx?PCode=G0340072,
28 Apr., 2012 visited.
10. http://law.moj.gov.tw/LawClass/ExContent.aspx?ty=C&K1=
&K2=&K3=&CC=D&CNO=536, 28 Apr., 2012 visited.
tual property as a pledge for a specified period of
time. There is no recourse against the securitized
asset(s)11 and the conveyance process shields them
from bankruptcy. The securitized asset(s) may be
partitioned and pooled according to similarities
to permit stable forecasting and management
of risks and to maximize profit generation. The
originator is allowed to be the service provider
for managing the securitized asset(s) in exchange
for a service charge.
(3) The Special Purpose Vehicle (SPV) or
issuer: the special purpose vehicle is the entity
that takes over control of the securitized asset(s)
to shield them from bankruptcy and that issues the
securities (for example, a subsidiary company or
the institute of underwriters). The special purpose
vehicle can be a trust, a company or any other legal
entity and depends on the local law or regulation
governing the situation, and the relevant tax offsets.12 In addition, its business scope should be
limited in order to simplify risk control.
(4) The Investors: the investors are the final
purchasers of the securities, such as the bank,
insurance company, pension funds, investing
company or corporate treasuries, and sometimes
retail investors.
(5) The Trustee: the trustee represents the investors in their negotiations with the credit enhancers, service providers, issuers, etc. Normally the
bank or trust will play this role. The issuer will
entrust the security interest to the trustee.13 In
Taiwan, the Financial Securitization Act, Article
77 states: “When issuing Asset-Backed Securities,
in order to protect the rights and interests of the
Asset-Backed Security holders, the special purpose
company (SPC) shall appoint a Supervisory Institution and shall enter into a supervision agreement
with the Supervisory Institution in compliance
with the asset securitization plan; provided, that
the SPC shall not appoint the Originator or Servicer set forth in the asset securitization plan as
the Supervisory Institution.”14 The supervisory
institute protects the rights for the investors.
11. See Steven L. Schwarcz, “The Alchemy of Asset Securitization,” 1 Stanford Journal of Law, Business & Finance 133,
135 (1994).
12. See Chen W-D, Lee A-Y, Lia S-S, “Principle and Practicum on Asset Securitization,” Zhi0Shan Cultural publisher, Aug
2002, p24.
13. See Diane Audino, “Securitization: The Rating Agency
Approach to Credit Risks,” Euromoney, 1996, p 21.
14. http://eng.selaw.com.tw/FLAWDAT0202.asp, 28 Apr,
2012 visited.
March 2014
61
(6) The Credit Enhancer: in order to manage
the credit risk, the credit enhancement mechanism is often applied to raise the credit rating
and encourage investment. There are two types
of credit enhancement mechanisms: (i) internal
credit enhancers; and (ii) external credit enhancers. These are applied according to the request
from the credit rating agency to provide the credit
enhancement measures requested by the credit
rating agency to maintain the desired credit rating.
(7) The Credit Rating Agency: the credit rating
agency is the party who provides the credit rating
for the securitized asset(s) and suggestions for
the risk control management thereof,15 as well
as the rating report used as a reference for the
investors to judge whether the particular pledge
is secure to pay for the principal and interest.16
The credit rating agency reviews the qualities of
the securitized asset(s), the abilities of the service
provider, the financial performance of the originator, the infrastructure of the securitization, the
securitization process itself, how the credits, etc.,
may be enhanced, and provides investors with
all the information thereon for their references
when examining their desire to invest in the securitization. Example of such rating agencies with
internationally esteemed reputation, are Moody’s
Investor Services, Standard & Poor’s Corporation,
Duff & Phelps and Fitch IBCA. The rating examples
from Standard & Poor’s Corporation or Moody’s
Investor Services can be something like AAA (S
& P) or Aaa (Moody’s). The minimum recommended investing ratings are BBB (S & P) or Baa
(Moody’s). According to the Taiwan Finance Asset
Securitization Act, Article 102: “The Asset-Backed
Securities or Beneficial Securities issued through
public offerings to non-specific people by the SPC
or the Trustee pursuant to this Act shall be rated
by a credit rating institution with the recognition
of the competent authority.”17 Any legislation
on biomedical patent securitization should, in a
similar fashion, mandate the inclusion of ratings
by such credit rating agencies in a similar fashion.
(8) The Underwriters/Placement Agents: the
underwriter is often a security corporation and
its duties are to analyze the market, recommend
15. See supra note 19, p25.
16. See Teresa N. Kerr, Bowie Bonding in “the Music Biz:
Will Music Royalty Securitization Be the Key to the Gold for
Music Industry Participants?,” 7 UCLA Ent. L. Rev. 367, 377
(Spring 2000).
17. http://law.moj.gov.tw/LawClass/LawContent.aspx?PCODE
=G0380122, 28 Apr 2012 visited.
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les Nouvelles
the infrastructure, price the securities and suggest a public offerings or private placements for
the securities for the investors. The underwriter
may promote the trading and act as an arranger to
integrate the comments from various professions
including legal, financial, tax and government
policy, etc.18
(9) The Servicer or Backup Servicer: the special
purpose vehicle is to shield the securitized assets
from bankruptcy of the owner or originator, and
it will not necessarily have the ability to manage
or operate the securitized asset(s). Therefore, the
servicer/back-up servicer will serve the role of
managing and operating the securitized asset(s)
and allocating profits to the investors according to
the securitization contract. In case the unexpected
situation happens, such as poor management or
bankruptcy of the servicer’s core business, which
hinders the servicer to perform in the securitization, a backup servicer will take over the duties
in the securitization.
If patents are involved in the securitization, the
servicer monitors the patent licensor to insure
fulfillment of the obligations and duties and to update the technology information in order to sustain
the securitization operation, as royalties are often
the main cash flow that warrants the particular
intellectual property securitization. Where the securitization of biomedical patents are concerned,
licensors often have to meet milestones for the
securitized biomedical patent (such as to pass the
review of FDA or accomplishing a specific stage of
clinical trial or the development of dosage form
or even better, a new indication which implies a
brand new market) to use this securitized patent
for an additional cash flow. The stability of the
cash flow from the securitized patent will affect
the credit rating, and if the servicer is able to not
only sustain the cash flow from existing patent
licensing, but also to develop new licensing for the
securitized patent, the cash flow performance will
be better than stable, which is beneficial for the
credit rating during the periods of securitization.19
The concept mentioned above can also be seen
in the Taiwan Finance Asset Securitization Act, in
chapter 2: special purpose trust, section 5 (Articles
18. See Chou Y-B, “Study Report for Basel International
Convergence of Capital Measurement and Capital Standards
and Assets Securitization,” Central Deposit Insurance, 2003,
p53.
19. See Wang J-C, “Financial Assets Securitization,” Wu-Nan
publisher, Mar 2005, p12.
34-36): rights and duties for the trustee, and section 6 (Articles 37-42): calculation, tax and related
issues for the special purpose trust.20
(10)The Professional Advisers: the professional
advisors are the experts from those professions
that are needed to conduct due diligence and
auditing. Examples of such people include legal
counsel to draft the legal documents, financial
experts, accounting advisors and patent experts
experienced with biomedical patent(s).
4.2Processes Involved in Legislation of
Biomedical Securitization
(2) Invite professional advisors and parties to
be involved in securitization process.
It is impossible to have all the experts and parties
from the very beginning of the securitization planning, however, the core members involved in securitization should be invited to form a team early,
on which can support the design of infrastructure
and arrange the deal with legal documents.
(3) Information analysis.
While, initially, there will be a preliminary analysis
as to whether the securitization can be successful,
at this stage, a thorough analysis is made of the
decision to initiate the
securitization process.
Figure 4. General Process For IP Securitization
The historical analysis of
the securitized asset(s),
the environmental analyIdentification and Investigation of the Underlying Asset
sis of the target market
and the whole economic
situation are all taken
The Establishment of
into account for detailed
Special Purpose
calculation, so as to provide as precise a forecast
as possible.
Underlying Asset Transfer
Credit Enhancement
(4) Refine the identified assets for securitiSecurities Issuance and Sale
Credit Rating
zation and process the
auditing.
In general, only an asset
Identification and InvestigaBased Asset Management
that can generate stable
tion of the Underlying Asset
and Services
cash flow or can be converted into predictable
amount of cash is allowed
The general process of intellectual property securifor securitization. The securitized asset(s) must be
tization can be summarized in the above flow chart.
able to generate sufficient cash flow to cover not
The securitization includes several steps that
only the principal but also any interest and services
more or less run simultaneously, however, the logicharges and credit rating agency charges and the
cal order is:
credit enhance mechanism adjustments as may be
(1) Identify the securitization target(s) and
required during securitization. Decisions are also
the process for the preliminary analysis of the
made as to whether it is better to pool the assets
asset(s).
at issue with other assets to diversify the holding
and lower the risks involved therewith. If so, after
The originator has to identify the needs for the
refining the securitized assets, the originator will
asset(s) which may possibly undergo securitizapool and partition the assets according to similarity
tion and preliminarily analyze them to decide
and process due diligence, reviewing documents
whether the securitization can be successful, and
to determine the intellectual property rights of the
thereafter, to design the best infrastructure for
pooled asset(s), auditing their administration and
the securitization according to the needs from
the asset(s).
related security interest and other obligations for
the creditors. In any event, the predictable cash
flow income must be greater than the overall costs
to pay, including the principal, interest, services
20. http://law.moj.gov.tw/LawClass/LawAll.aspx?PCode=
G0380122, 29 Apr 2012 visited.
charges and related expenses.
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63
(5) Set up special purpose vehicle and perform
true-sale.
In order to shield the securitized assets from
bankruptcy, a true-sale of the assets is a must to
separate the securitized asset(s) from the originator. In the United States, this special purpose
vehicle can be a trust, a corporation, a limited
liability partnership, or any other legal entity, as
long as it can perform the fundraising purpose.
In the end, the final choice will be determined
mainly by the needs of the originator, whether
the tax off-set can be achieved and the purpose
of this trading. Furthermore, the special purpose
vehicle must meet the requirement of being out
of the control of the originator or the patent(s)
owner to shield them from creditors in the case
of bankruptcy to protect investors.
(6) Take care of the trading structure and audit
from time to time internally.
The special purpose vehicle and the originator
will enter into a service contract whereby the
originator is to take care of the securitized asset(s),
a trustee (i.e. a bank) is to be assigned to represent the investors, an underwriter agreement is
prepared, and a credit rating agency is hired to
evaluate the designed infrastructure for the securitization. Similar requirements can be found
in the Taiwan Financial Asset Securitization Act,
chapter 3: special purpose company, section 8,
Articles 85-8921 for the business scope of the special purpose companies in patent securitizations.
(7) Credit enhancement and circulation
improvement.
In order to improve the credit rating and attract
more investors, the special purpose vehicle can undergo the credit enhance mechanism to improve
the credit rating or the issuing conditions based
on the advice from the credit rating agency. These
measures are to ensure liquidation of the debts. In
case there may be temporary cash shortfalls from
the securitized asset(s), the third party (such as a
bank or an insurance company) provides liquidity
as a contingency, or a back-up arrangement for
the special purpose vehicle to cash out for paying
the investors.
(8) Process the credit evaluation and issue the
securities.
After credit enhancement, the special purpose
vehicle hires a credit rating agency to provide an
21. http://law.moj.gov.tw/LawClass/LawAll aspx?PCode=
G0380122, 29 Apr 2012 visited
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evaluation of the securitized asset(s) and announce
the credit rating to be applied thereto by the
Agency for the investors’ reference. Thereafter,
the underwriter arranges the sale of these securities to investors for public or private placements.
(9) Obtain income from the issued securities
and pay the originator the agreed price.
The special purpose vehicle receives income from
the underwriter and pays the originator the agree
price for its fundraising purpose.
(10)Manage the assets with payment for the
principal and interest.
The servicer manages the pooled asset(s) and
bookkeeping profits from the securitized asset(s),
sometimes even to pursue legal action if payment
is delayed. The profits are saved in an account
established by the special purpose vehicle for
this purpose. Upon maturity, the special purpose
vehicle pays investors the principal and interest
then due.
5. Legislation Among Countries on Patent
Securitization
In Taiwan, patent securitization has not yet been
legislated and the related legal issues can only apply under the “Company Act,” the “Securities and
Exchange Act,” the “Financial Asset Securitization
Act” and the “Clauses of the Real Estate Securitization Act.”
Based on the custom in Taiwan, a specific law and
regulation on patent securitization is highly recommended for facilitating fundraising needed for the
development of patented technologies.
Like Taiwan, there is no specific law or regulation
in the United States specifically concerning patent
securitization, with resort being made instead to the
Uniform Commercial Code and the Securities and
Exchange Act being the primary legal bases currently
used. Nonetheless, the registration of the transfer of
the intellectual property rights and of the securitization interest are recommended as stated in the 35
U.S.C. 261 Ownership and Assignment:22
“An assignment, grant or conveyance shall be void
as against any subsequent purchaser or mortgagee
for a valuable consideration, without notice, unless
it is recorded in the Patent and Trademark Office
within three months from its date or prior to the
date of such subsequent purchase or mortgage.”
In addition, each of the individual states that make
22. http://www.uspto.gov/web/offices/pac/mpep/documents/
appxl_35_U_S_C_261.htm, 26 Apr 2012 visited.
up the United States has its own law and regulation
concerning registration and its effects.
Japan is similar to the United States in that a registration system for assets conveyance is also applied.23
There are several theories discussing how to define
the assets conveyance in Japan. A registration system
with a public announcement is preferred to protect
an innocent third party from double selling. There are
several research companies receiving funding from
the Japanese Policy Investment Bank by providing
intellectual property rights as financial guarantees,24
which indicates that intellectual property securitization is already being used in the Japanese capital
market. Japanese trust law was amended to accommodate intellectual property rights in 2004. The
other laws and regulations relating to application of
securitization in Japan are the Japanese Patent Act,25
the Japanese Bankruptcy Act (specifically Article
53: Bilateral Contract) and Civil Law Section IV Assignment of claims in Japanese civil law (specifically
Articles 466-473), which, in Article 469 states that:
“The assignment of any debt payable to order may
not be asserted against the relevant obligor or any
other third party unless the certificate representing such claim is tendered to the assignee with
the endorsement of the relevant assignment.”26
Which is reinforced by 466 (2) which states that:
“… where the parties have manifested their intention to the contrary; provided, however, that such
manifestation of intention may not be asserted
against a third party without knowledge.”
In Taiwan, for the time being, the applicable law
and regulation to be applied for the issues involved
in securitization are the Patent Act, the Civil Act,
the Company Act, the Securities and Exchange Act ,
the Trust Act, the Financial Asset Securitization Act,
Clauses of the Real Estate Securitization Act and the
Bankruptcy Act. According to Article 6 of the Taiwan
Patent Act, the:
“…patent right are both assignable and inheritable…In the case of taking a patent right as the
23. See Huang M-J, “Basic Principle on Securitization,” Financial Law, Yuan-Jau publisher, 2007, pp239-243, 249.
24. See “Dynamic Fundraising on Intellectual Property,” in
the Investigation Report of Intellectual Property Circulation and
Fundraising Cases Studies, by Economic and Industry Department, Dec 2007, p45.
25. See Nahoko Ono, “Intellectual Property as GuaranteeCurrent Issues in Japanese Intellectual Property Law,” PhD thesis from Hitosubashi University Law school, Nov 2011, p 4.
26. http://ishare.iask.sina.com.cn/f/12992168.html?from=
like, 28 Apr 2012 visited.
subject of a pledge, the pledgee shall not be allowed to put the patent under pledge into practice, unless otherwise provided for as a covenant
in an agreement.”
Furthermore, Article 59 states that:
“The assignment, trust or licensing made by the
patentee of the patent right of an invention to
another person to practice the invention, or the
pledge created on the patent by the patentee shall
not be asserted against any third party, unless it
has been registered with the Patent Authority.”
And Article 74 provides that:
“The grant, alteration, extension, prolongation, assignment, trust, licensing, compulsory licensing,
revocation, extinguishments or pledging of an invention patent right as well as other matters which
should be published, the Patent Authority shall
effect such publication in the Patent Gazette.”27
Article 62 extends that principle to joint owners of
patent rights (“A joint-owner of an invention patent
shall not assign or entrust his/her share thereof to
another person or create a pledge on the same patent,
without the consent of all the other joint-owners.”)
The above mentioned articles in Taiwan show that
the law in individual countries is becoming internationally harmonized, since the concepts and principles in the existing law and regulations are somehow
similar to that in the United States, Japan and Taiwan,
although the applicable laws were legislated in different acts or chapters with minor differences to cope
with local environment. Regarding the conveyance
of the intellectual property rights, registration with
the patent and trademark office is recommended and
the protection for the innocent third party should be
maintained, in view of the complicated patent right
assignment involved.
6. Overseas Biomedical Securitization
Cases Studies
There have been several successful cases involving
securitization of biomedical patents that can provide
models for us to refer to when examining different
scenarios involving this type of instrument.
6.1Case I: Securitization for Investment
in Development
The first case study we shall examine is a traditional
one involving a large pharmaceutical company: the Eli
Lilly securitization of Semagacestat for raising funds
needed for clinical trials.
27. http://law.moj.gov.tw/Eng/LawClass/LawAll.aspx?PCode
=J0070007, 28 Apr 2012 visited.
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65
Eli Lilly, one of the top ten pharmaceutical
companies in the world, securitized Semagacestat
for U.S. $300 million through TPG-Axon Capital
Management, LP and NovaQuest in order to raise
funds for paying Quintiles, a world class clinical trial
organization, to perform clinical trials for two candidate drugs. For 300 million U.S. dollars, TPG-Axon
provided 90 percent of development funding while
NovaQuest provided 10 percent, backed by royalties
and milestone fees from three of Lily’s Alzheimer’s
drug candidates, including Semagacestat.
TPG-Axon Capital Management, LP (TAC) is a globally famous private hedge fund, providing services
to high tech individuals, pension funds, and banking
institutions; its main interests are healthcare, pharmaceuticals, financial services, technologies, new
energies, and basic materials and retails.
NovaQuest is a unique value-added-reseller (VARs)
and distributor. The NovaQuest business is focused
on small-to-medium enterprises, providing expertise
in industrial equipment, life sciences, consumer
goods, high-tech, CPG, and apparels.
This case study shows that, even with a world class
organization, knowledge experience and expertise,
the securitizations are not guarateed for, according to
a 17 August 2010 official announcement on Eli Lily’s
website:28 Lilly has since halted further development
of Semagacestat for Alzheimer’s Disease based on the
preliminary results of the Phase III Clinical Trials. This
Semagacestat case thus also demonstrates the need
for various mechanisms used in securitization, such
as vehicles to shield the asset from bankruptcy and
the pooling of assets to provide greater security and
higher guarantees for the buyer.
6.2Case II: Single Technology From University
and Marketer
The second case study we shall examine, that of the
securitization of “Zerit” by Yale University, points out
the difficulties encountered with properly evaluating
the royalty and income streams of drug and other
biomedical products and the problems that can arise
when this evaluation is not properly made.
BioPharma Royalty Trust structured a securitization of “Zerit” (Stavudine; 2’-3’-didehydro-2’-3’dideoxythymidine, d4T), which was protected by a
patent from Yale University and licensed to BristolMyers Squibb Co., who were to pay royalties as a
guarantee for the securitization of 115 million U.S.
28. http://www.aidsinfonet.org/fact_sheets/view/414, visited
on 9 Dec 2012.
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les Nouvelles
dollars, including 57.15 million U.S. dollars in senior
debt, 22 million U.S. dollars in mezzanine debt and
22.16 million U.S. dollars in equity, for securities that
were awarded a single A rating by Standard & Poor’s
in October 2000.
The transaction was completed based on the track
record of royalties from 1992 to 2000, which had
shown that such compounds had a 24 percent compound annual growth rate. Biopharma Royalty Trust’s
senior notes were due quarterly beginning from 6
Sept. 2000 to 6 June 2006, supported by a strong
legal structure, that segregated the revenue stream,
from the credit support provided by subordinate debt
and equity investors, and the strength of the historical
and projected royalty revenues provided by the Zerit
patent. In addition, the excellent AAA credit rating
of Bristol-Mayers Squibb Co.—a leading international
pharmaceutical company—itself. The underwriter/issuer of Biopharm Royalty Trust was Royal Pharma AG
and the senior holder was Westdeutsche Landesbank
Girozentrale in London.
Nonetheless, because this securitization was based
on a single product (Zerit), it carried an inherently
higher risk than in cases where several products
are involved. This is because market conditions and
assumptions of compound rates (and market share
that a drug will achieve) can never be predicted with
absolute certainty, and errors in the process become
much more pronounced.
In the case of Zerit, this turned out to be the case
due to the following reasons:
(1) Zerit was indicated for acquired immune
deficiency syndrome (so called “AIDS”), and the
majority of patients suffering from AIDS are from
the developing countries who are normally unable
to pay for the treatment—a factor that was not
properly accounted for in the valuation;
(2) Health reimbursement systems are different in every country and medications for AIDS
are often too expensive to be covered by public
reimbursement systems—again a factor that was
not properly accounted for in the valuation; and
(3) Although the prevalence or incidence of the
patient pool was large, the available patient pool
who could afford the drug was difficult to achieve
based the health reimbusement system worldwide—once again, a factor that was not properly
accounted for in the valuation.
While, for Yale University, this was a successful securitization as Bristol-Mayers Squibb Co. paid royalty
based on the licensing agreement, and the funding
raised from this particular securitization was then
used for its intended purpose. However, from the
investors point of veiw, the Zerit securitization was
not able to deliver the expected financial benefits due
to various factors, one of which was an overly optimistic assumption of 24 percent compound growth
rate. Fortunately, this securitization period was only
from 2000-2006, otherwise, there would have been
additional downside for investors as the World Helath
Organization subsequently announced a recommendation that Zerit was not suitable for initial treatment
of HIV infection in 2009, which further limited its
market size. Furthermore, certificates permitting the
introduction of generic competition were granted by
United States Food and Drug Administration in the
U.S. market further negatively impacting the drugs
market share.29
6.3 Case III: Pooled Assets From Leading
Biotechnology and Pharmaceutical
Companies
The third case study we shall examine points out
the advantages of pooling assets to be securitized in
providing security and advantages for investors and to
avoid the problems that were encountered in the Zerit
securitization discussed in the previous case study.
The current trend is towards the securitization of
preferred pooled assets in order to prevent intentional
or unintentional mistakes or forecasting errors, such
as those that were seen in the Zerit case. An example
of such a securitization was the Royalty Pharma Finance Trust’s 225 million U.S. dollar securitization
of variable funding notes, structured by Credit Swiss
First Boston in 2003 with AAA rating by Moody’s and
Standard & Poor’s for a pool of drugs from various
companies. The insurance company was MBIA Insurance Group, which was involved in the insurance of
this securtization, and the trustee was Deutsche Bank
Trust Co. America.
This securitization involved a three-year revolving
borrowing period with a seven-year expected maturity, in combination with quarterly amortization. The
special purpose vehicle involved with this transaction
issued securities for a pool of 13 drugs from various
companies, such as, Genetech’s and Biogen Idec’s
Rituxan®, Celegen’s Thalomid®, PrePro® from Eli
Lilly and Johnson & Johnson/Centocor, Centocor’s Retavase®, Chiron’s TOBI®, Norvatis’ Simulect®, Roche’s
Zenapax®, Ligand’s Targretin® Capsules, Memorial
Sloan Kettering’s Neupogen/Neulasta®, Organon’s
Variza®, Glaxo Smith Kline and Adolor’s Entereg®,
Pfizer’s lasofoxifene® and Wyeth’s Bazedoxifene®.
29. http://www.aidsinfonet.org/fact_sheets/view/414, visited
on 9 Dec 2012.
In January 2004, a portion of the royalty interest in
Neupogen/Neulasta®, which belonged to the Memorial Sloan Kettering Cancer Center, added a further
U.S. $263 million into the bankruptcy-protection
vehicle and the investor insisted that there also be a
U.S. $7 million dollar investment in Royal Pharma. At
the start of this transaction, the royalty assets were
owned by the offshore company Royalty Pharma AG,
while, at closing, the assets were sold on to an Irish
Trust, which was a newly formed Delaware business
trust established for the purpose of providing the
securitization with a shield from bankruptcy claims.
Nine of the drugs were launched in the market
within 5 years, with the patents involved having
expiration dates that fell between 2005 to 2015.
Performance of this portfolio generated 4.4 billion
U.S. dollars in sales, about 49 million U.S. dollars
in royalty and contingent payment rights to Royalty
Pharma AG in a calendar year. The licensees of the
contingent payment rights were owned by a diverse
group of investment trade companies.
6.4 Case IV: Securitization Through
Litigated Assets
The fourth case study involves a case where funding
was sought for the IP assets in question, in order to
enforce the very IP assets that were the subject of the
securitization: thus meaning that the very assets that
were securitized were being put at risk by their use.
Emtricitabine (FTC), a fluorinated version of lamivudine (3TC), was discovered and patented by Emory
University, and subsequently licensed to Triangle
Pharmaceuticals in 1996. Later, Triangle Pharmaceuticals was acquired by Gilead Sciences, who completed
development and secured market authorization for
the drug from the FDA on 2 July 2003. Therefore, the
right to market FTC was owned by Gilead Sciences.
Lamivudine (3TC) was marketed by Glaxo, which
had obtained it when Glaxo acquired BurroughsWellcome. Both FTC and 3TC were produced by a
process for the synthesis of BHC-189, this process
had been previously licensed by Emory to Burroughs
Wellcome prior to its acquisition by Glaxo. However,
Emory claimed that Glaxo has improperly obtained
the rights to the synthesis patent and to 3TC itself.
Emory University filed an action against Glaxo for
the rights to the BHC-189 synthesis patent on the
grounds that Wellcome had misappropriated the intellectual property of Emory’s inventors, and that the
intellectual property and patents covering FTC were
originally from Emory University. In addition, Emory
University demanded the rights to the clinical trial
data that had been generated relating to FTC.
March 2014
67
Emory also faced patent challenges on other fronts
with challenges having also been launched by Shire
Pharmaceutical and BioChem Pharmaceutical.
In the end, Emory University was able to maintain
the rights for both 3TC and FTC. The FTC monetized
securitization by Emory University was conducted
during the ongoing litigation:
1. February—September 2004: Emory University
held internal discussions to monetize FTC and/or
3TC royalty streams for securitization;
2.October 2004—February 2005: Emory University employed an experienced financial advisor
Citigroup and Covington & Burling as outside legal
counsel;
3. March—June 2005: Due Diligence process was
conducted with various parties;
4.July 2005: Emory University conducted final
negotiations in New York, and sale contracts with
an Amended and Restated License Agreement
were executed;
5.At the close of the transaction, Gilead and
Royalty Pharma paid Emory University 525 million U.S. dollars for all FTC royalties. In addition,
Gilead paid 15 million U.S.D. for amending and
restating the license agreement to Emory University;
6.Regarding the 525 million U.S. dollars, it was
agreed that Gilead and Royalty Pharma would pay
65 percent and 35 percent, respectively, to Emory
University and the Inventors within 30 days of the
closing date- July 21, 2005;
7.Emory University and the inventors acquired
an interest from Royalty Pharma approximating 25
percent of the proceeds paid by Royalty Pharma
during the transaction; and
8.Gilead was obligated to pay to Royalty Pharma
royalty revenue based on future FTC net sales.
This case was the largest sale of royalty interests
to date in the pharmaceutical sector, with significant
interest from investors, sponsors and hedge funds.
Based on the Citigroup’s profound knowledge for
asset management and potential buyers assisted valuation, significant interest in the securitization was
generated, which created competition to expedite
signing and closing. Gilead’s stock went up about
3 percent (about 625 million U.S. dollars) on the
announcement day. Considering that Gilead’s costs
was only 65 percent out of the 525 million U.S. dollars (341.25 million U.S. dollars), Gilead was able to
realize a profit of 283.75 million U.S. dollars on the
transaction.
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Lamivudine (3TC) is the only oral medication for
hepatitis B, and there are more than 130 million
people in China that still suffer from hepatitis B. In
this case, 3TC was demonstrated to be useful for a
new indication (to treat AIDS) which greatly increased
the cash flow. We learn from this case how fierce competition can be in the pharmaceutical industry and
how the value of the innovation can be greatly compensated. Emory University was able to raise funds
permitting it to carry on for 6 years in litigation and
received quite a payoff in return. However, dangers
still exist as China launched a compulsory licensing
amendment effective on 1 May, 2012, and Lamivudine (3TC) was the first drug to be possibly granted
compulsory licensing, which further enhanced the
importance of FTC.
7. Recommendations
Biomedical (including pharmaceutical) technologies
require a huge amount of resources and time to maintain the intellectual property and fund the technology until it reaches the market.30 Securitization is an
innovative financial tool that offers a mechanism to
link capital markets with intellectual property rights
in such a manner that IPRs are accepted as pledges
for fundraising.31 Adoption of characteristics of the
current Financial Asset Securitization Act for future
legislation permitting intellectual property rights to
serve as a basis for financial securitization for biomedical technologies is recommended.
However, governance to insure proper financial
control is crucial, as it can be recklessly used and
can trigger economic crises. Certainly, it is unforgettable regarding the catastrophic recession caused by
Lehman Brothers years ago, which caused tens of
trillions of U.S. dollars lost and doubled the American national debt with 30 million people out of jobs
worldwide. However, the deregulation of the financial
industry in United States for over 30 years gave opportunities for the system to be misused, something
which needs to be safeguarded against if biomedical
patent securitization is to be successful.
7.1Overseas Fundraising and Guarantor
Institutions
In Japan, Tetsuya Komuro securitized the future
royalties of his 806 songs from his music CDs in
exchange for 1 billion Japanese yen from Fuju Bank32
30. See Adam Grant, “Ziggy Stardust Reborn: A Proposed
Modification of the Bowie Bond,” 22 Cardozo L. Rev. 1291,
1296 (2001).
31. See David Edwards, “Patent Backed Securitization: Blueprint for a New Asset Class,” http://www.securitization.net/pdf/
gerling_new_0302.pdf, 18 May 2007 visited.
in order to buy digital music equipment and recording facilities needed to produce yet more songs and,
presumably, more revenue.33 Fuji Bank required
Tetsuya Komuro to sign the rights in the assets to an
asset management company to manage the royalties
for these songs in the securitized CD.
In the United States, companies like IP Innovations
Financial Services, Inc. (IPI), exist whose core business specialized on intellectual properties evaluation
and the raising of funds using this IP as security. As
an off-shore company, Royal Pharm, also specializes in
the securitization of biomedical patents, with several
successful cases like Yale University on Zerit and many
others biomedical patents.
There is also the need to execute Technology
Escrow Contracts for intellectual property to be
accepted as a mortgage guarantee, in which the
targeted intellectual property is transferred to a
custodian company under the terms of an escrow
contract, which the company verifies and evaluates
and manages the assets.34 The true example of such
an agreement was Norand—a software company with
many valuable patents and copyrights, which was
acquired by a biotech company through the help of
the custodian company in 198835 by offering funding
and deposit verification for the secured intellectual
properties and accounting status reports of Norand.36
In Taiwan, the government supports and provides
trust funds for small and medium size enterprises to
pledge their intellectual property.37 Considering the
great expectation on biomedical patent securitization, even though it can be a sophisticated and costly
mechanism, it is one that offers enormous benefits
and protection for the parties involved.
7.2 Opinions from Scholars
There are differing opinions as to whether legislation on patent securitization is a must or whether
the application of the current laws and regulations
32. http://www.fujibank.co.jp/, 4 May 2012 visited.
33. See Liu H-D, “Current Situation and the Future for Financial Institutes to Handle the Intellectual Property Fundraising,”
master thesis from graduate school of Management in National
ChengChi University, p35, Dec 2004.
34. See Jeremy Lewis, Andrew Moore, “Ensuring IP Protection Through Escrow,” 21 Entertainment and Sports Lawyer 8
(spring 2003).
35. See Liu J-B, Yan R-C, King T-L, Shi J-F, “Study on the Intellectual Property as Guarantee, Protection and Application of
Intellectual Property in China and Taiwan,” Yuan-Jau publisher,
July 2002, p148.
36. See Jeremy Lewis, Andrew Moore, supra note 36, p8.
37. See Chen W-L, “Introduction of Evaluation and Fundraising on Intangible Assets in Taiwan,” National Lwyer, Vol.
10, no. 1, 32-34, Jan 2006.
is sufficient, since neither the United States nor European countries have specific legislation on patent
securitization. Therefore, the following scenarios
were reviewed to try to resolve these differences.
7.2.1Application of the Current Financial Assets
Securitization Act in Taiwan
Adoption of the current Finance Asset Securitization Act is one of the suggestions for biomedical
patent securitization: the related monitoring from
the government can be provided for under Article
9 (apply, approval and registration); creditor right
transfer and notification can all be provided for
under Articles 5 and 6; and rules regarding fees and
tax off-sets are all provided for under Articles 38-41.
Furthermore, securities offerings can apply special
rules and risk management control and the trading
expenses discount can apply, in a fashion similar to
those applied to financial asset securities. However,
there are some limitations in these extensions of
the law and regulations and so-called “grey areas”
would remain, such as the scope of the rights of the
originator, how to define assets, capital restrictions,
and operation models.
Nonetheless, many scholars do not agree that intellectual property rights should be qualified as the
securitized assets. According to the Financial Asset
Securitization Act, the definition of assets includes
such things as rent, credit card debt, payment receivable or other moneywise creditor’s right in Article
4 (paragraph 2, part 3). Thus, it would appear that
intellectual property may be qualified as a payment
receivable or other moneywise creditor’s right. However, if that is not the case, then consideration should
be given to amending part 5 in Article 4-paragraph 2
of the Financial Asset Securitization Act, to provide
that intellectual property rights can be an option.
Again, there are scholars who worry whether “future debt” can be adopted into the Financial Asset
Securitization Act as the assets mentioned in Article
4, paragraph 2 (car mortgage, house mortgage, rent,
credit card debt or payment receivable, etc.) presently
exist at the moment that the credit is extended as
a creditor’s right. However, the cash flow to be securitized is the anticipated royalty from the licensed
contract or the future licensing contract that is based
on the intellectual property right. Thus, it is not present and certain. This raises the issue as to whether
the future creditor’s right can be applied to the current Financial Asset Securitization. Therefore, if the
biomedical patents are to be covered in the current
Financial Asset Securitization, then an amendment of
Part 5, Paragraph 2 in Article 4 must be made before
March 2014
69
implementation.
7.2.2An Independent Legislation on Biomedical
Patent Securitization
For better implementation and to better encourage
the capital market, the establishment of legislation
on biomedical patent securitization is highly recommended.38 This new law can follow the framework
of the existing Financial Asset Securitization Act and
incorporate useful concepts of the Trust Act. While it
is inevitable that people will debate whether or not
the unique features of intellectual property right and
future royalties from the existed licensing and future
licensing means that biomedical patents should not
be considered as financial assets, it is indisputable,
that there are similarities between intellectual properties and financial assets which should justify their
being able to be used as collateral for the securing
of funding.39
7.2.3 Author’s View on Biomedical Patent Securitization Legislation
To provide better protection and safeguards for
patent and other intellectual property-based asset
securitization, a registration system for publicizing
the trading and conveyance of the rights would appear to be essential. The intellectual property right
is authorized by patent and trademark office, the
maintenance status can be searched online, but there
is no compulsory enforcement. In the United States,
the future creditor’s right is allowable for conveyance
in the Uniform Commercial Code (U.C.C.), Article 9.40
However, registration of the security interest with an
appropriate authority is a must to claim the security
right in the event that any dispute arises.
In Taiwan, the Supreme Court case, 90 Tai-Sun-Zi,
no. 1438, confirmed that the conditional creditor’s
right can be conveyed.41 The registration system was
originally established for recording security interests
in real estate and financial assets. However, such a registration system can be extended to provide a further
protection for investors and help to prevent risk and
disputes relating to the security interest and the rights
38. See Tsuei K-W, Chen Y-S, “The Prior Study on Intellectual
Property Securitization,” Security Market Development, 147,
2005.
39. See Chen Y-T, “Advantage and Crisis for the Future of
Intellectual Property Securitization,” Technology Law Analysis,
Vol 17, no. 9, 3, 2005.
40. See Wang W-Y, “Basic Studies on Legislation of Assets
Securitization,” Yue-Dan Law Journal, no. 88, 118-119, 2002.
41. See Supreme Court case, Tai-Sun-Zi no. 1438, http://jirs.
judicial.gov.tw/FJUD/FJUDQRY01_1.aspx,.
70
les Nouvelles
of the various parties in the secured assets. The future
creditor’s right may be conveyed in Taiwan based on
that Supreme Court judgment. Therefore, the future
creditor’s rights, such as the right to receive royalty
based on future or existing licensing contracts should
be available to be securitized.
In particular, special attention on reviewing the licensing contracts of the targeted intellectual property
is required, in case they have a clause prohibiting their
conveyance. Since the beginning of the securitization
is a true-sale between the originator and the special
purpose vehicle, sometimes a third party, such as a
trust, will need to be included in the securitization
as a second special purpose vehicle for additional
protection for the securitized patents, in case their
conveyance is prohibited by the licensing contract of
the securitized patent, this can lead to the failure of
the whole securitization.
Flaws in the assets or unsatisfactory outcomes may
happen or only become apparent after securitization,
especially where biomedical or drug patents are
involved, in that, there are many unexpected circumstances, both scientific/medical as well as legal, which
are beyond control of the parties. Such scientific/
medical problems include unexpected side effects
on minority of human being, low market acceptance,
government policy changes (for example, compulsory
licensing) and amendments to FDA regulations to
name but a few. Such legal problems include patent
validity, true inventorship (in the USA) and prior user
rights that only first arise during litigation and can
provide challenges to the underlying patent rights
causing them to fail.
In the event of legal failures, securitization provides
investors with a measure of security in that, if the
patent rights are sustained and existed during the
securitization period,42 the licensor is not liable for
the loss or damages on the future developments or
outcomes.43
In the event of scientific/medical failures, investor protection is provided by credit enhancement
and risk management mechanisms included in the
securitization infrastructure (such as the special
purpose vehicle and vehicles to shield the assets from
bankruptcy). This is understandable in that there are
42. See Supreme Court case, Tai-Sun-Zi no. 4297, http://jirs.
judicial.gov.tw/FJUD/FJUDQRY01_1.aspx, 8 Aug 2012 visited.
43. See Taiwan Patent Act, article 73, paragraph 2, http://
www.tipo.gov.tw/ch/Download_DownloadPage.aspx?path=161
6&Language=1&UID=13&ClsID=14&ClsTwoID=15&ClsThre
eID=28, 8 Aug 2012 visited.
various factors that impact on the success of patent
implementation, such the qualities of the product (i.e.
made in developed countries vs. made in developing
countries), commercialization design, manufacturing
standards and marketing investments, macroeconomics, etc., and against which risk needs to be hedged.
All of the foregoing point out the need and advantages of providing “special-built” legislation to provide
for the opportunities and to minimize, to the greatest
extent possible, the risks that patent securitization
provides instead of merely trying to adapt existing
legislation to do the task; so that government monitoring for a higher level of protection to investors and to
the economy as a whole while providing innovators
and companies with the benefits of access to funds
for further innovation and development. ■
March 2014
71
Recent U.S. Decisions
Recent U.S. Court Decisions And Developments
Affecting Licensing
By John Paul and Brian Kacedon
Keurig, Inc. v. Sturm Foods, Inc.
The Sale of a Patented Apparatus Exhausts
Patent Rights to Methods Covering the
Normal and Intended Use of the Apparatus
The exhaustion doctrine in patent law precludes a
patent owner from asserting patent rights to control
the use of an apparatus after an authorized sale. In
Keurig, Inc. v. Sturm Foods, Inc., the Federal Circuit
held that a patent owner’s rights to a patented method
are exhausted when the patent owner sells an apparatus with a normal and intended use of practicing the
method. The Federal Circuit also stated that exhaustion is determined on a patent-by-patent basis, not a
claim-by-claim basis. This latter portion of the Keurig
decision is significant for patent owners because it
could have additional ramifications for those whose
patents cover both method and apparatus claims.
Background
Keurig makes single-serving beverage brewers. To
make a beverage, a consumer inserts a cartridge into
the brewer, the brewer then forcing hot water through
the cartridge, dispensing the beverage. Keurig sells
both the brewers and the cartridges to consumers.
Keurig’s brewers embody the apparatus claims of two
of its patents. These two patents also include method
claims, which are practiced by Keurig’s brewers when
making beverages. Sturm Foods, Inc., sells cartridges
that can be used with Keurig’s brewers, but does not
make or sell the brewers.
Keurig sued Sturm alleging that consumers’ use
of Sturm’s cartridges in Keurig’s brewers directly
infringed certain method claims of Keurig’s patents.
Keurig alleged that Sturm induced and contributed to
infringement by selling cartridges for use in Keurig’s
brewers. Sturm argued that Keurig’s patent rights
to assert the method claims were exhausted when
Keurig sold its brewers to the consumers. The district
court agreed with Sturm, holding that Keurig’s rights
were exhausted and granting Sturm’s motion for summary judgment of noninfringement. Keurig appealed.
The Federal Circuit’s Decision
On appeal, Keurig admitted that the sale of the
brewers exhausted its rights to assert the apparatus
claims of its two patents but argued that it could still
assert the method claims against use of the brewers
72
les Nouvelles
with Strum’s cartridges. The Federal Circuit affirmed
the district court’s ruling that applied exhaustion to
all uses of Keurig’s brewers.
The court first considered the Supreme Court’s
Univis and Quanta decisions, which involved the
sale of unpatented articles that embodied patented
methods. The Federal Circuit distinguished Univis
and Quanta because the brewers sold by Keurig
were patented articles, rather than nonpatented
articles embodying a patented method. The Federal
Circuit also noted that Keurig did not assert any of
its cartridge-related patents against Sturm, but only
the method claims covering the use of Keurig’s brewers with Sturm’s cartridges. The court applied the
principle that Keurig’s authorized sale of a patented
apparatus grants the purchaser the right to use the
apparatus so long as it is capable of use. Thus, when
Keurig sold the patented brewers to consumers, the
consumers obtained an unrestricted right to use
them as they chose, including using cartridges sold
by a third party.
The Federal Circuit reasoned that allowing Keurig
to assert the method claims against Sturm would
amount to an impermissible post-sale restriction on
consumers’ use of the brewers because Keurig could
control which cartridges a consumer must purchase
and use with the brewers after the initial sale. The
Federal Circuit also stated that a consumer’s ability
to use cartridges that would not infringe the patented
methods did not prevent exhaustion of Keurig’s two
patents, which are directed to the brewers and methods of using the brewers. As a result, Keurig could
not preclude an individual who purchased a Keurig
brewer from using a non-Keurig cartridge and could
not preclude a third party from selling cartridges to
use in Keurig’s brewers.
The Federal Circuit, rejecting Keurig’s argument
that exhaustion must be determined on a claim-byclaim basis, observed that the exhaustion jurisprudence discusses exhaustion of patents, not exhaustion
of claims, and that when both method and apparatus
claims are included in a single patent, all of those
claims are judged together for exhaustion purposes.
The Federal Circuit reasoned that a claim-by-claim
exhaustion analysis would vitiate the exhaustion
doctrine and create uncertainty about which rights
are exhausted by an authorized sale. Because at least
one claim was exhausted by Keurig’s sale of brewers,
so were all of Keurig’s rights in its two patents.
Judge O’Malley concurred in the judgment. She
agreed that Keurig’s initial authorized sale of the
patented brewers exhausted its rights for those
brewers, including the claimed methods practiced by
brewers’ normal and intended use. Judge O’Malley
reasoned, however, that determining whether patent
rights are exhausted on a patent-by-patent basis or
a claim-by-claim basis was not necessary to reaching
this result. In Judge O’Malley’s view, therefore, this
portion of the court’s opinion should be considered
dictum, and she dissented from the majority to the
extent that it held that patents are exhausted on a
patent-by-patent basis.
Strategy and Conclusion
The Keurig decision provides another example of
patent exhaustion and signals that the Federal Circuit
(and therefore district courts, too) may apply a broad
patent-level analysis. Application of the doctrine may
limit a patent owner’s ability to assert its patent
against third-party consumable manufacturers when
the patent covers a method of using the apparatus
sold by the patent owner. The court’s statements that
patents are exhausted on a patent-by-patent basis
(rather than a claim-by-claim basis) and that a different
analysis may have applied to a patent directed to the
cartridges themselves may raise possible implications
in patenting and licensing strategies where a single
patent includes both method and apparatus claims.
Fresenius USA v. Baxter International
Federal Circuit Declines to Revisit Its Ruling
That A Pending District Court Judgment Of
Patent Infringement Can Be Nullified When
the PTO Invalidates and Cancels the Patent
Claims During Reexamination
In Fresenius USA v. Baxter International, a divided
Federal Circuit declined to rehear its earlier decision
holding that the PTO’s cancellation of patent claims
could nullify a pending district court judgment, even
when much of that judgment had already been affirmed on appeal. The denial for rehearing shows the
continuing debate over the controversial administrative nullification of Article III judgments.
The America Invents Act has altered many areas of
patent law, but perhaps one of the most significant
changes has been the increased ability to challenge
the validity of a patent in administrative proceeding
before the U.S. Patent and Trademark Office (“USPTO”). It is not uncommon that such administrative
proceedings occur in parallel with proceedings before
U.S. Courts. One challenge for the courts, however,
is to determine the interplay between decisions of
the USPTO and the court, particularly when those
decisions conflict.
Background
This case concerned three patents owned by Baxter
International related to a hemodialysis machine. The
relevant claims taught the use of the machine with
an integrated touchscreen interface. Fresenius USA,
Inc., Baxter’s competitor, filed a declaratory-judgment
action in the Northern District of California, seeking
an order declaring the patent claims invalid and not
infringed. Baxter counterclaimed for infringement.
Fresenius stipulated to
infringement, but a jury
■ John C. Paul,
found the claims invalid
Finnegan, Henderson, Farabow,
as obvious or anticipated.
Garrett & Dunner, LLP,
The district court, howAttorney,
ever, held that Fresenius had not presented
Washington, D.C., USA
substantial evidence to
support those findings.
■ D. Brian Kacedon,
As a result, the district
Finnegan, Henderson, Farabow,
court entered judgment
as a matter of law in favor
Garrett & Dunner, LLP,
of Baxter. After a later
Partner,
trial on damages, the jury
Washington, D.C., USA
awarded $14.266 million
E-mail: brian.kacedon@
to Baxter for infringefinnegan.com
ment. The district court
entered that judgment
as well as an injunction. In Fresenius’ appeal, Fresenius I, the Federal Circuit affirmed the judgment of
infringement on one patent but partially reversed,
holding that two of the asserted patent’s claims were
invalid. The court, therefore, remanded the case
to the district court to reconsider the scope of its
injunction and postverdict damages award in light of
the new invalidity determinations.
Following this mandate, the district court reduced
Baxter’s postverdict royalties and ordered Fresenius
to pay Baxter $14.266 million (plus interest) in
prejudgment damages, $9.3 million (plus interest)
in postverdict royalties on infringing machines, and
additional royalties on related sales. Again, both
parties appealed the district court’s order and the
district court stayed execution of its judgment pending appeal.
Meanwhile, at Fresenius’ request and beginning
during the district-court litigation, the PTO reexamined the relevant patent claims (those ultimately
surviving invalidity during the first appeal). Before
March 2014
73
the district-court case went to a trial on damages
(before the first appeal), the patent examiner made
an initial determination that the patent claims would
have been obvious in light of two prior-art references.
Importantly, the claims before the PTO comprised all
the remaining claims in the district-court litigation.
Despite the parties’ requests to stay the case pending
reexamination, the district court determined that the
uncertainty of the PTO’s final determination did not
warrant a stay.
The PTO Board of Patent Appeals and Interferences
ultimately found the claims obvious and thus invalid—
a decision affirmed by the Federal Circuit. The obviousness holding from the reexamination relied on
two prior-art references that “were not squarely at
issue” in the related district court proceeding. Thus,
on appeal (In re Baxter), the Federal Circuit held
that the only remaining patent was invalid and did so
while the parties were appealing damages from the
reconsidered damages award (Fresenius II).
The Panel Decision (Fresenius II)
On appeal, the Federal Circuit held that the PTO’s
cancellation of claims was binding in the pending district court case such that the district court judgment
then pending on appeal was rendered moot due to
the nullification of claims. The court noted that final
judgments could not be reopened but that remand
in Fresenius I prevented the finality of the judgment,
so it was still nonfinal when the Federal Circuit affirmed the PTO’s cancellation of Baxter’s claims in
In re Baxter. In particular, the court found significant
that its remand did not sufficiently end the dispute
between the parties or “leave nothing for the court to
do but execute the judgment”—instead the remand
required reconsideration of damages issues.
Judge Newman dissented from the panel majority,
challenging the constitutionality of the majority’s
holding by arguing that separation of powers precluded an administrative agency from superseding
a judicial proceeding by stripping all effect from
the district court’s judgment and Federal Circuit’s
affirmance.
Decision on Rehearing
Following the court’s July 2 decision, Baxter filed a
combined petition for a panel rehearing and rehearing
en banc (asking the full complement of active judges
to review the decision by the three-judge panel). The
court has now denied both requests. The concurring
opinion and two dissenting opinions that accompanied
the denial, however, illustrate the continued division
in the Federal Circuit over the administrative nullification of Article III judgments.
74
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1. Judge Dyk’s Concurrence
The concurrence written by Judge Dyk, and joined
by Judge Prost, directly responded to the dissents to
the denial of rehearing, largely renewing the finality
arguments made in the panel’s majority decision.
Specifically, Judge Dyk explained that Moffitt, Simmons, and Mendenhall compelled the result in this
case because the district court’s judgment was not
sufficiently “final” to bar the preclusive effect of the
Federal Circuit’s nullification of the patents in In re
Baxter in light of the court’s remand to the district
court on post-verdict relief. Under Judge Dyk’s view
of the precedent, the court must distinguish between
the preclusive effect of (1) the first appeal on later
infringement proceedings and (2) the affirmed PTO
decision on any infringement proceeding. While the
first appeal may have affected another infringement
case, the court determined that it did not affect
the PTO proceeding. After looking at the case law
regarding preclusion effects in nonfinal cases, Judge
Dyk concluded that the dissents’ arguments simply
contravened longstanding circuit and Supreme Court
authority.
2. Judge O’Malley’s Dissent
Judge O’Malley’s dissent articulated a different
understanding of the procedural posture of the case,
which she argued compelled the opposite conclusion.
Because the court’s remand to the district court
concerned only postverdict relief and not infringement, validity, or preverdict damages, Judge O’Malley
viewed the district court’s judgment as final in at least
those respects. Highlighting that neither the district
court nor the circuit itself could have disturbed those
aspects of the judgment, Judge O’Malley argued that
Baxter’s entitlement to damages was final and thus
immune from In re Baxter’s preclusive effect.
Judge O’Malley also distinguished the facts of
Fresenius from those of the cases cited by the panel
majority and by Judge Dyk. Arguing that Baxter’s right
in the judgment vested by virtue of a calculation of
preverdict damages and appellate review of that calculation, Judge O’Malley dismissed reliance on Simmons and Mendenhall because neither of those cases
similarly involved an appeal from a judgment with a
completed accounting. Judge O’Malley’s dissent also
took issue with what she viewed as a conflict with
Bosch v. Pylon Manufacturing, in which the Federal
Circuit applied a “liberal view” of finality to conclude
that liability determinations are final for purposes of
appeal even though damages and willfulness determinations remain pending.
3. Judge Newman’s Dissent
As she had from the panel majority, Judge Newman dissented from the denial of rehearing, again
pointing to constitutional concerns. First, Judge
Newman argued that the panel’s decision would
destabilize the patent system by ignoring the rules of
finality in patent disputes. In doing so, she observed,
the court weakened the driving force of the patent
system: the incentive for creating, developing, and
commercializing new technology. Second, Judge
Newman confronted Judge Dyk and Judge O’Malley’s
characterization of her position on the role of reexamination, arguing that she does not disfavor parallel
proceedings in district court and the PTO, but rather
opposes “routinely subjecting Article III judges to
agency override.” Judge Newman distinguished the
Federal Circuit’s approach from other circuits, which
she characterized as respecting the rules of finality.
In light of Fresenius, a final PTO decision affirmed
by the Federal Circuit is given effect in pending district court cases so long as the judgment is not yet
final. Thus, a district court’s judgment on validity and
infringement may, under certain circumstances, be
superseded by the Federal Circuit’s later affirmance
of the PTO’s invalidity decision.
This case illustrates the effect that PTO proceedings
can have on parallel district court litigation. Practitioners should remain aware that nonfinal district
court judgments could be superseded by a final administrative nullification of claims. This consideration
grows in importance now that the AIA has provided
additional avenues of postgrant review. The new inter
partes review proceedings, for example, provide an
accelerated review mechanism in which the PTO
can reexamine and invalidate claims within twelve to
eighteen months. With most district court litigation
extending beyond this period, an increasing number
of invalidity determinations will have the potential to
moot pending district court disputes. Parties should
carefully examine their litigation strategies when
involved in parallel proceedings.
Apple Inc. v. Samsung Electronics Co.
Patent Owners Must Show a Causal Nexus
Between the Harm and the Infringement
When Seeking a Permanent Injunction
In a patent-infringement action, whether a prevailing patent owner can obtain a permanent injunction
against the infringer depends on the district court’s
discretion and a number of factors specified in the
eBay case, including whether the patent owner has
been “irreparably harmed” by the infringement. In
Apple Inc. v. Samsung Electronics Co., the Federal Circuit held that a patent owner must establish a causal
nexus between the infringement and the irreparable
harm as part of the first eBay factor. According to the
court, the patent owner can establish the causal nexus
by showing “some connection” between the patented
feature and consumer demand. The Federal Circuit
also held that the district court erred in its analysis
of a second eBay factor by considering Samsung’s
ability to pay a monetary judgment and by disregarding Apple’s evidence that its past licensing conduct
substantially differed from the circumstances at issue.
Background
In 2011, Apple sued Samsung, asserting that Samsung infringed three utility patents owned by Apple.
The jury found that 26 of Samsung’s smartphones
or tablets infringed one or more of Apple’s patents
and awarded monetary damages. After the jury trial,
Apple moved for a permanent injunction to block
Samsung from importing or selling any of the 26
infringing products. The U.S. District Court for the
Northern District of California declined to enter a
permanent injunction, finding that three of the four
eBay factors weighed in Samsung’s favor, while the
remaining factor weighed in neither party’s favor.
Regarding the first factor, irreparable harm, the
district court found that Apple failed to show that
consumers buy the accused Samsung products specifically because of the infringing features and thus
held that Apple failed to demonstrate a causal nexus
between the injury and the infringement. More specifically, the district court rejected as “too general”
Apple’s three causal-nexus arguments: that “ease
of use” is an important factor in phone choice; that
Samsung deliberately copied Apple’s patents; and that
survey results show that consumers would pay more
for the patented features. The district court also took
issue with Apple’s failure to show irreparable harm
on a patent-by-patent basis and thus found the first
eBay factor in Samsung’s favor.
On the second factor, inadequacy of legal remedies,
the district court accepted Apple’s argument that it
had lost downstream sales of products, which could
not be calculated with reasonable certainty or fully
compensated by money damages. But the district
court found that because Apple had previously licensed its utility patents to other manufacturers, the
patents were not “priceless” and could be assigned
a monetary value. The district court also found that
because Apple had previously offered to license some
of its patents to Samsung, Samsung was not “off
limits” as a licensee. These findings taken together
March 2014
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with Samsung’s ability to satisfy any monetary judgment led the district court to find the second factor
in Samsung’s favor.
In view of Samsung’s representation that it no longer sold 23 of the 26 infringing products, the district
court found the third factor, balance of hardships,
favored neither party.
On the fourth and final factor, the public interest, the district court held that the public interest
would not be served by prohibiting the sale of entire
products where only limited, noncore features of
the products actually infringed. The district court
therefore denied Apple’s request for a permanent
injunction, and Apple appealed.
Finding no clear error of judgment or law in the
district court’s analysis of the third and fourth eBay
factors, the Federal Circuit did not disturb them. On
the first and second factors, however, the Federal
Circuit found that the district court abused its discretion and, as a result, vacated and remanded the issue
back for further consideration.
On the first factor, irreparable harm, the Federal
Circuit found that the district court properly required
Apple to show a causal nexus between the irreparable
harm and infringement. Pointing to a statement
by the Supreme Court that the standard for a preliminary injunction is “essentially the same” as for a
permanent injunction, the Federal Circuit reasoned
that the causal-nexus inquiry should apply to both
preliminary and permanent injunctions. None of the
cases Apple cited established otherwise. The Federal
Circuit rejected Apple’s argument that a causal-nexus
requirement would import an unprecedented fifth
factor to the eBay factors. The court explained that
a causal-nexus inquiry is part of the irreparableharm factor, serving to distinguish irreparable harm
caused by patent infringement from irreparable
harm caused by otherwise lawful competition. For
this same reason, the Federal Circuit also rejected
Apple’s argument that a strong showing of irreparable
harm could offset weak evidence of a causal nexus.
In other words, because causal nexus forms a part of
irreparable harm, without a showing of causal nexus
there can be no relevant irreparable harm.
Though the Federal Circuit found the district court
properly required a showing of causal nexus as part
of the first eBay factor, it rejected the district court’s
strict application and the finding that Apple failed
to show a causal nexus, and it provided two guiding
principles to evaluate causal nexus. First, the patent
owner needs to show only “some connection between
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the patented feature and demand,” not that the patented feature is “the exclusive reason for consumer
demand.” And second, there may be circumstances
where the patent owner can show a causal nexus by
viewing the patented features in the aggregate, as
opposed to on a patent-by-patent basis. For example,
it may be appropriate to view the patents collectively
where the patented features relate to the same technology or combine to make a product “significantly
more valuable.”
Evaluating the three types of evidence Apple relied
on to establish a causal nexus, the Federal Circuit
shed further light on what may or may not constitute
a causal nexus. First, Apple’s evidence that “ease of
use” is an important factor in phone choice—which
did not relate the actual patented features to consumer demand—did not, by itself, establish a causal
nexus. Next, evidence of Samsung’s intent to copy
Apple’s patents, though relevant, also did not, by
itself, establish a causal nexus. Finally, the Federal
Circuit explained that surveys showing consumers’
willingness to pay more for products incorporating
the patented features may be relevant to a causal
nexus. Thus, the Federal Circuit found error in the
district court’s disregard of the survey results and
remanded the issue to the district court for further
analysis, including whether the combination of “ease
of use,” willful copying, and survey evidence sufficed
to establish a causal nexus.
The Federal Circuit also disagreed with the district
court’s assessment of the second eBay factor—inadequacy of legal remedies. Though an infringer’s
inability to pay a monetary judgment may be properly
considered (because it may support the conclusion
that monetary damages are an inadequate remedy), an
infringer’s ability to pay a monetary judgment should
not be used against a patent owner’s claim that monetary damages are insufficient. And, while it is appropriate to consider the patent owner’s past licensing
conduct in determining whether monetary damages
are sufficient, the analysis must focus on whether
monetary damages adequately compensate for the
actual infringer’s infringement of the patents-in-suit.
The district court improperly focused on Apple’s past
licenses with other companies but overlooked that
the licenses were with non-smartphone manufacturers or were entered into to settle litigation. Likewise,
the district court improperly focused on the fact
that Apple and Samsung had engaged in licensing
discussions in the past but disregarded the fact that
such discussions did not involve the patents-in-suit.
Thus, that Apple had licensed some of its patents to
other companies and had earlier licensing discussions
with Samsung merely showed Apple’s willingness to
license some of its patents, in some circumstances.
These facts, contrary to the district court’s reasoning,
did not conclusively show that monetary damages
adequately compensated for Samsung’s infringement.
This case provides guidance from the Federal Circuit in analyzing whether a patent owner had been
irreparably harmed by the infringer and entitled to an
injunction. First, the patent owner needs to show only
“some connection” between the patented feature and
consumer demand, not that the patented feature is
“the exclusive reason for consumer demand.” And
second, there may be circumstances where the patent owner can show a causal nexus by viewing the
patented features in the aggregate, as opposed to on
a patent-by-patent basis, such as where the patented
features relate to the same technology or combine to
make a product “significantly more valuable.”
This case also shows that a patent owner’s past
licensing conduct is not necessarily dispositive of
whether monetary damages adequately compensate
for the harm caused by infringement. Rather, a district court must consider differences that may exist
and that may distinguish the prior licensing conduct
from the circumstances of the infringement in the
case being considered by the court.
Fusionbrands, Inc. v. Suburban Bowery
Court Finds Venue Proper for Infringement
Claim Brought Against Small Internet
Reseller Based on Sales through
Amazon.com Storefront
For many companies, the Internet has become
the predominant point of sale for their products
as websites make it easy for anybody to become an
online retailer. Companies should consider, however,
whether those online sales may subject them to
jurisdiction for potential patent-infringement claims
in a larger number of courts. A recent order from
a district court in Georgia summarizes a number
of issues surrounding jurisdiction based on selling
products online. In particular, the court focused on
whether selling products through an online storefront
provided a basis for jurisdiction. It also considered
whether venue should be transferred. After a lengthy
analysis, the court determined that it had jurisdiction
and that a transfer of venue was not proper.
Background
The plaintiff in that case, Fusionbrands, Inc.,
manufactures and sells a silicone egg poacher under
the trademarked name PoachPod. Fusionbrands sued
the defendant, Suburban Bowery of Suffern, claiming that Suburban Bowery infringed Fusionbrands’
PoachPod patents and trademarks. In a letter to the
court, Suburban Bowery’s owner admitted to buying
1,000 PoachPods and selling them through his own
website as well as through a storefront on Amazon.
com. He stated that he sold the product to two customers through his own website. One of those two
customers was a legal secretary of Fusionbrands’
counsel who made the purchase as part of the case,
which Fusionbrands conceded. In his letter to the
court, however, the Suburban Bowery owner did not
address Fusionbrands’ claim that Suburban Bowery
sold the products through an Amazon.com storefront
or that those sales totaled over $6,000. Thus, the
court accepted as true the plaintiff’s allegations that
at least some of those sales were in the Northern
District of Georgia.
In addition to this letter to the court, Suburban
Bowery later filed a motion to dismiss for improper
venue or, alternatively, to transfer the case to the
Southern District of New York.
The District Court’s Decision
The district court first analyzed the venue. At the
outset, it rejected Fusionbrands’ claim that by merely
having an Amazon.com storefront, Suburban Bowery
could properly be sued in the court’s district (or,
for that matter, any district in the United States).
The court explained that the venue statute specifically applying to copyright and patent cases provides
venue either (1) in the district “where the defendant
resides” or (2) in the district “where the defendant
has committed acts of infringement and has a regular
and established place of business.”
Similarly, the court also rejected the contention
that infringing acts by the defendant in the forum
were enough to establish venue. If that were
enough, it would render the extra requirement
of a “regular and established place of business” in
the second prong of the venue statute superfluous.
Thus, to establish that venue was proper, the plaintiff needed to demonstrate that the defendant either
“resided” in the district or committed infringing acts
and had a regular and established place of business
in the district.
The court thus began its analysis by determining
whether the defendant “resided” in the district as required by the venue statute. A corporation’s residency
for venue purposes is any judicial district in which the
corporation is subject to the court’s personal jurisdiction for the civil action in question. Recognizing that
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77
Federal Circuit law governs the issue of jurisdiction
for patent cases, the court looked to the Federal Circuit’s test for jurisdiction. For personal jurisdiction
to exist, the Federal Circuit requires that two factors
be met: (1) the forum state’s long-arm statute must
permit service of process on the defendant and (2)
the assertion of personal jurisdiction must not violate
due process.
With respect to the first factor, the court looked
to Georgia’s long-arm statute. That statute allows
personal jurisdiction over any non-resident who
transacts any business in Georgia. The court found
that the defendant transacted business within Georgia because, as the court had previously explained,
it must accept plaintiff’s allegation that sales of the
infringing product occurred within its district.
With respect to the second factor, the court noted
that personal jurisdiction consistent with constitutional due process can be established through either
general jurisdiction or specific jurisdiction. General
jurisdiction arises when a defendant maintains continuous and systematic contacts with the forum state
even when the claim has no relation to those contacts.
Specific jurisdiction, on the other hand, arises out of,
or relates to, the claim for relief even if those contacts
are isolated and sporadic.
Beginning with general jurisdiction, the court found
that the defendant’s activities were insufficient to justify general personal jurisdiction because the plaintiff
demonstrated only that the defendant sold PoachPod
in the court’s district, and nothing more. As the Supreme Court has said, “mere purchases made in the
forum State, even if occurring at regular intervals, are
not enough to warrant a State’s assertion of general
jurisdiction over a nonresident corporation in a cause
of action not related to those purchase transactions.”
Turning next to specific jurisdiction, the court explained that specific jurisdiction is available when: (1)
a defendant purposefully directs its activities at the
forum; (2) the asserted claim arises out of, or relates
to, those activities; and (3) assertion of personal
jurisdiction is reasonable and fair.
The court recognized that the Internet has provided
a unique context for the “purposefully directed”
prong of the specific-jurisdiction analysis. Citing to
other cases on the issue, the court explained that,
at one end of the spectrum are situations where a
defendant clearly does business over the Internet. On
the other end are passive websites that simply convey
information to its visitors, who, due to the nature
of the Internet, can be anywhere in the world. In
the middle are websites that allow some interaction
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among their visitors but are not purely commercial in
nature. The court, relying on the plaintiff’s unrebutted claim of sales through an Amazon.com storefront
of over $6,000, found that this case falls into the first
category, where a defendant clearly does business
over the Internet.
The court found that second specific-jurisdiction
factor was satisfied because the sale of the PoachPod
was the basis for Fusionbrands’ infringement claim.
Therefore, the asserted claims clearly arose from the
activities directed at the forum.
On the final specific-jurisdiction factor, the court
likewise found that that the assertion of jurisdiction
was reasonable and fair. Specifically, the Supreme
Court has recognized that where a defendant has
been found to have purposefully directed his activities at forum residents, the defendant must present
a “compelling case” to defeat jurisdiction. Suburban
Bowery had not made the required compelling case.
Having determined that venue was proper (and
therefore denying the defendant’s motion to dismiss
for lack of venue) because the defendant “resided” in
the district within the meaning of the venue statute,
the court next looked at the defendant’s motion to
transfer the case to the Southern District of New
York. For the convenience of parties and witnesses,
in the interest of justice, a district court may transfer
any civil action to any other district where it might
have been brought. There are many factors relevant
to this venue-transfer analysis: (1) the convenience
of the witnesses; (2) the location of relevant documents and the relative ease of access to sources of
proof; (3) the convenience of the parties; (4) the locus
of operative facts; (5) the availability of process to
compel the attendance of unwilling witnesses; (6) the
relative means of the parties; (7) a forum’s familiarity with the governing law; (8) the weight accorded
a plaintiff’s choice of forum; and (9) trial efficiency
and the interests of justice, based on the totality of
the circumstances.
On the convenience of the witnesses and parties,
the defendant had not produced any evidence about
the location of the potential expert witnesses and
customers who might testify on the merits of the
case, and it would be equally inconvenient for the
plaintiff to travel to New York as it would be for the
defendant to travel to Georgia. As a result, these
factors weighed against transfer.
On the location of relevant documents, the defendant had not presented any evidence of what
the relevant documents might be, how expansive
the document list is, or why transporting the neces-
sary documents would be prohibitively expensive
or inconvenient. As a result, this factor weighed
against transfer.
On the relative means of the parties, the court
noted that both plaintiff and defendant are small business owners with no major difference in their available resources. As a result, this factor was neutral.
On the weight accorded to a plaintiff’s choice
of forum, the court recognized that a plaintiff’s
choice should not be disturbed unless it is clearly
outweighed by other considerations and that a plaintiff’s home forum is where the plaintiff had filed. As
a result, this factor weighed heavily against transfer.
On trial efficiency and interest of justice, the court
found that the defendant had not presented any
evidence to support its argument that a transfer was
necessary because the defendant may want or need
to implead a third-party defendant. As a result, this
factor did not weigh in favor of transfer.
On the remaining factors, the defendant had conceded that those factors do not weigh in its favor.
Taking all these factors together, the district court
found that the defendant had not shown that a transfer was warranted.
The Fusionbrands order serves as a reminder of
the various aspects that come into play when selling
products over the Internet. It also serves as a good
guide for an analysis of some of the issues relating
to jurisdiction and venue.
Microsoft v. ITC
Evidence of Examples of Software Provided
to Third Parties for Implementation in
Products Held Insufficient to Satisfy the
ITC Domestic Industry Requirement
In recent years, some patent owners have turned
to the ITC, with its fast-paced proceedings, as a way
to quickly protect their product market. But before
excluding infringing products from entering the U.S.,
the ITC requires patent owners to show that they
meet the ITC domestic-industry requirement under
19 U.S.C. § 337, a hurdle that is not required for
relief in district courts. A patent holder may satisfy
the domestic-industry requirement by showing that
it, or its licensee, produces protected products representing a significant investment in the domestic
marketplace.
In Microsoft v. ITC, the Federal Circuit affirmed
the ITC’s decision that Microsoft had failed to show
a domestic industry for products using its patent in
the U.S. because it relied on example software rather
than actual instances of use. Without a connection
between the example software code and actual devices implementing that code, the court held that
Microsoft lacked sufficient basis on which to make
the required showing.
In reviewing the ITC’s decision, the Federal Circuit
noted that “[t]here is no question about the substantiality of Microsoft’s investment in its operating
system or about the importance of that operating
system to mobile phones on which it runs.” But the
ITC’s governing statute requires more than simply
showing operations in the United States. Instead, the
focus under section 337 is on whether a company can
show that its domestic investments include products
covered by the asserted patents in order to merit
statutory protection.
Microsoft failed to provide sufficient evidence at
the ITC that domestic cell phones actually practiced
the patents asserted. One evidentiary problem, the
Federal Circuit explained, was that while Microsoft offered expert testimony regarding example
programs and source code, it did not introduce any
evidence regarding the final implementation of the
software. Specifically, Microsoft did not provide any
direct evidence that these example programs were
actually implemented by third parties. Moreover,
Microsoft’s expert had not examined the third-party
software to determine whether it in fact used the
patented systems.
The Commission faulted Microsoft for not offering
expert examination of third-party software, because
it left the Administrative Law Judge (“ALJ”) unable
to confirm how these devices “actually operate.” The
ALJ explained that, although Microsoft had provided
hypothetical examples, it had not proven that actual
devices used the patented system. And without that
evidence, the ALJ found, Microsoft lacked proof that
its patents covered a domestic industry.
The first patent the Federal Circuit considered
for the domestic-industry requirement related to
software architecture for notifying applications of
changes to the state of mobile-device components.
Specifically, the patent discloses a “notification broker,” and the ALJ construed the claims to require
this notification broker to directly communicate with
applications outside the broker.
For evidence on domestic industry, Microsoft’s expert examined an example application that Microsoft
March 2014
79
provided to third-party application developers and
concluded that the application used the patented
structure. But, standing alone, that example application could not establish that end users actually use
similar applications. Such a showing would have
required proof that the code was implemented on
third-party mobile devices, which Microsoft did
not introduce into evidence. Thus, according to the
Federal Circuit, the ALJ lacked sufficient evidence
about how client applications on actual “articles”
operated and in turn could not conclude that Microsoft practiced the patent domestically.
Similarly, the Federal Circuit upheld the Commission’s determination that Microsoft had not
proven a domestic industr y practicing its patent
directed to a radio interface layer (RIL) between
radio hardware and software applications in a cell
phone. As with the “notification broker” patent,
the ALJ found that Microsoft’s evidence failed
to prove users actually operated phones in a way
that was practicing the patent because Microsoft
presented evidence of an example driver layer
that practiced the patent but did not offer any
direct evidence of third-party mobile devices that
implement the software. This failure to show
actual implementation of the patent-containing
code defeated Microsoft’s claim to section 337
protection.
Microsoft also offered evidence of phones implementing its Windows Mobile operating system,
code that practices the patent. While discussing
the operating system, however, Microsoft’s expert
relied on the sample code rather than actual code
from the implemented systems. Here again, the evidence failed to prove users actually bought phones
implementing the patented system. Applying a
deferential standard—whether substantial evidence
supported the Commission’s findings—the Federal
Circuit refused to reverse the Commission’s finding
that Microsoft failed to show a domestic industry
protected by the patent.
This case addresses evidentiary considerations
pertaining to the ITC’s domestic-industry requirement. In particular, this case demonstrates the
importance of showing how the asserted patents
are connected to actual products in the domestic
marketplace. By only showing how the patents are
connected to example products that may or may
not be in the domestic marketplace, a patentee will
likely not meet the domestic-industry requirement.
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les Nouvelles
Buckhorn Inc. v. Orbis Corp.
Federal Circuit Enforces Fee-Shifting Provision in Settlement-and-License Agreement,
Awarding Attorney Fees To A Defendant Who
Prevailed On A License Defense Provided by
the Agreement Even Though The Plaintiff
Was Unaware of the Impact of the Agreement
When It Began the Litigation
Due to the constantly changing nature of the corporate environment, individuals with full knowledge
of agreements entered into by a corporation often
do not remain with the corporation throughout the
life of every agreement they negotiate. Thus, it is not
uncommon that a corporate licensing executive may
not have complete knowledge of every agreement
entered into by the corporation or their impact on
the company. In Buckhorn Inc. v. Orbis Corp., the
plaintiff brought suit for infringement of a patent
apparently unaware that the defendant had a license
to that patent under an agreement entered into by
predecessor corporations. Despite this lack of knowledge, the Federal Circuit, in an unpublished opinion,
enforced a fee-shifting provision in that agreement,
awarding attorney fees to the defendant who was the
prevailing party, and held that such enforcement was
not unconscionable.
Background
In 1990, Schoeller’s predecessors-in-interest, collectively Xytec, brought a patent-infringement action
against Orbis’ predecessor-in-interest, Ropak, over
certain bulk containers used in the materials-handling
business. A 1992 settlement-and-license agreement
resolved the litigation and provided Ropak with a
license to four patents and any corresponding child
patents, which included the ’927 patent and its child,
the ’592 patent.
The 1992 agreement contained several key provisions. A fee-shifting provision provided that, “[i]n any
litigation based on a controversy or dispute arising
out of or in connection with this Agreement or its
interpretation, the prevailing party shall be entitled
to recover all fees, costs, reasonable attorney’s fees,
and other expenses attributable to the litigation.”
Another provision required Xytec’s express written
consent before Ropak could transfer the licensed
rights to a competitor, “except in connection with
the sale or merger of substantially all of Ropak with
another such entity.”
Ropak’s corporate structure changed over the
years. In 2000, Ropak transferred its materialshandling business, including its rights under the
1992 agreement, to LMH. In 2006, Orbis acquired
LMH and changed its name to OMH. Also, in 2007,
Schoeller licensed the ’592 patent to Myers. That
license allowed Myers to assert infringement of the
’592 patent and to transfer its rights and obligations
under the agreement to a subsidiary without notifying Schoeller. After Myers’ wholly owned subsidiary,
Buckhorn, brought the present action against Orbis
and OMH in 2008, OMH merged into Orbis in 2009,
thereby purporting to transfer all of OMH’s assets to
Orbis—including its rights under the 1992 agreement. In 2010, the ’592 patent expired.
Then, almost two years after OMH merged into
Orbis, the district court granted summary judgment
on Orbis’ affirmative-license defense, finding that
it was licensed as the successor-in-interest to the
rights under the 1992 agreement for the ’592 patent and that the transfer of those rights to Orbis was
consistent with the 1992 agreement. Those findings
resolved most of the suit in Orbis’ favor. But the district court denied Orbis’ subsequent motion for fees
and costs from Schoeller, which Orbis sought under
the fee-shifting provision of the 1992 agreement. The
district court found that the fee-shifting provision did
not apply because the plaintiffs had no knowledge of
the license at the time of suit and further because
enforcing the provision would be unconscionable.
The Federal Circuit, applying state contract law,
found that the “clear and explicit” fee provision language did not require knowledge of either the 1992
agreement or the scope of the rights thereunder at
the time of filing. Further, the court deemed the fee
provision not unconscionable, as the 1992 agreement
was fair when entered into and the fee provision did
not produce an overly harsh result.
The court first examined the alleged knowledge
requirement to enforce the fee provision. Initially,
the Federal Circuit clarified that, although the trial
court stated that the plaintiffs lacked knowledge of
the 1992 agreement, Schoeller in fact produced the
1992 agreement in discovery; rather, Schoeller only
denied being aware that the 1992 agreement covered
the ’592 patent. Regardless, the court explained, the
parties to that agreement intended to resolve future
disputes over the ’927 patent and its progeny, namely,
the ’592 patent, with a broadly worded fee provision.
In the Federal Circuit’s view, the trial court did not
give proper effect to the “in connection with” language in the fee provision. Specifically, this litigation
related to the rights under the Agreement, and the
“clear and explicit” fee provision language did not
require any knowledge of the Agreement or those
rights at the time of filing.
Next, the court examined whether enforcement of
the fee provision was unconscionable. Applying state
contract law, the Federal Circuit looked at both procedural and substantive unconscionability. The court
reiterated that unconscionability must be determined
at the time of contracting; the district court erred by
looking at events after the 1992 agreement, rather
than at the time Ropak and Xytec entered into that
agreement. According to the Federal Circuit, Ropak
and Xytec were sophisticated business parties that
thoughtfully worked out a settlement to resolve both
the ongoing litigation and future disputes. Further,
the fee provision was not overly-harsh because it was
reciprocal, as it would inure to the benefit of either
prevailing party.
Finally, the Federal Circuit distinguished the provision’s alleged unconscionability from the reasonableness of the fee award to Orbis. Schoeller argued in
support of the trial court’s unconscionability finding
that Orbis and OMH were in a better position to
assess the validity of the transfer of rights under the
1992 agreement and that Orbis and OMH delayed
producing evidence about the changes in the corporate structure of their predecessors-in-interest.
Specifically, Schoeller argued that it did not know
whether the exception in the provision governing
the transfer of the rights granted applied—Ropak
needed Xytec’s express consent to transfer the
license except when “in connection with the sale
or merger of substantially all of Ropak with another
such entity”—because of the delayed production of
evidence. The Federal Circuit clarified that the delay
might impact the reasonableness of the fee award on
remand, but that it would not affect Orbis’ lawfully
received rights under the 1992 agreement.
This case highlights some of the challenges faced
by licensing executives in the corporate environment
who, due to frequency of corporate restructuring,
may be unaware of the existence, scope, or impact of
license agreements that affect the corporation. This
case also highlights the possible implications of agreeing to fee-shifting provisions in license agreements. ■
Acknowledgement
The authors acknowledge with appreciation
the assistance of Jason Melvin, Eric Jeschke, and
Doug Meier.
This article is for informational purposes and does
not constitute legal advice. The views expressed do
not necessarily reflect the views of LES or Finnegan.
March 2014
81
Notes
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Yibin FENG
David SU
Denisa SVECOVA
Marc BETHENOD
Peter K. HESS
Katalin DERZSI
Sunil KRISHNA
Dalit SAGIV
Gian Antonio PANCOT
Kiyotaka WATANABE
Hyoseon CHOI
Michelle LOI CHOI JOKE
Carlos Trujillo
May CANIBA-LLONA
Jakub MRDZOWSKI
Velery MEDVEDEV
Per ERICSSON
Suresh SACHI
Darren MARGO
José Miguel LISSÉN
Stefan KOHLER
Murat IDAL
Paul ROBERTS
March 2014
LES International
Licensing And Intellectual
Property Organizations Meetings
For more information on LESI Meetings, go to www.lesi.org
2014
March 20–22
LES ANZ 2014 Conference
Perth, Australia
March 25–27
LES (USA & Canada)
Mid-Year Meeting
New York, New York USA
April 7-8
Certified Patent Valuation
Analyst (CPVA)
Training Course
Dubai, United Arab Emirates
April 26
Around the World with LES
WIPO’s World IP
Observance Day
May 16–18
LESI Management &
Delegates’ Meeting (IMDM)
Moscow, Russia
May 18–21
LESI Annual Conference
Moscow, Russia
October 5–8
LES (USA & Canada)
Annual Meeting
San Francisco, California USA
November 5-6
LES Asia Pacific Regional Conference 2014
Seoul, Korea
les Nouvelles
J. Gay
M. Finnegan
B. Hedberg
M. Okano
D. Smith
J. Gaudin
J. Stonier
S. Heijn
W. Poms
H. Hodding
F. Pombo
M. Ariga
L. Mackey
P. Hug
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
April 10–12
LESI Management &
Delegates’ Meeting (IMDM)
Brussels, Belgium
April 12–15
LESI Annual Conference
Brussels, Belgium
April 26
Around the World with LES
WIPO’s World IP
Observance Day
October 25-28
LES (USA & Canada)
2015 Annual Meeting
Brussels, Belgium
D. Ryan
K. Payne
J. Portier
F. Noetinger
A. Mifune
L. Evans
O. Axster
N. Jacobs
J. Brown
S. Layton Jr.
R. DeBoos
P. Mandros
H. Goddar
Chairs & Co-Chairs
Audit
Awards
Communications
Education
2015
Endowment
External Relations
Investment
IP Maintenance
Legal
Long-Range Planning
Meetings
Membership
Nominations
Peter Hess
Heinz Goddar
Thierry Sueur Ned Barlas
Jeff Whittle
Rob McInnes
Dwight Olson
Art Rose
Patrick O’Reilley
Sun Kim
Yorikatsu Hohokabe
Jonas Gulliksson
Wisam Hirzalla
Ron Grudziecki
François Painchaud
Junichi Yamazaki
Russell Levine
Fiona Nicholson
Alan Lewis
Arnaud Michel
Jim Malackowski
LESI Industry, Professional &
Regional Committees
Industry
Chemicals, Energy,
Environmental & Materials
Consumer Products
High Tech
Life Sciences
Rashid Kahn
Achim Krebs
Christopher Shaowei
Andreas Winkler
John Paul
Pamela Cox
Professional
International Past-Presidents
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
LESI Management Committees
2001 E. Shalloway
2002 T. Sueur
2003 M. Jager
2004 J. Gulliksson
2005 W. Manfroy
2006 P. Chrocziel
2007 R. Grudziecki
2008 C. Fukuda
2009 A. Liberman
2010 P. O’Reilley
2011 A. Lewis
2012 J. Malackowski
2013 K. Nachtrab
Copyright Licensing
Dispute Resolution
Industry/University
Government Transactions
Patent & Tech Licensing
Trademarks
IP Valuation
Regional
Americas
Africa and Middle East
Asia Pacific
European
Michael Lechter Tom Filarski
Claire Driscoll
Pauline Khor
Martin Schneider
Dwight Olson
Marcela Trigo de Souza
Mohammed Al-Ansari
Kevin Dam
Audrey Yap
Junko Sugimura
Bruno Vandermeulen
Ad Hoc Committees
Business Forums
Global Technology
Impact Forum
Bill Elkington
Young Members Congress
IP Strategy
Tilman Mueller-Stoy
Subramaniam Vutha
Hector Chagoya
Martin Schneider
Notes
Notes:
March 2014
Notes
Notes:
les Nouvelles
Notes
Notes:
March 2014
Notes
Notes:
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www.e-mergeglobal.com
2014 SEMINAR SERIES
ADVANCED PATENT &
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well as how to address significant licensing issues.
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All seminars are held at BSKB’s offices in
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We are the patent and technology research company
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Client: Birch, Stewart, Kolasch & Birch, LLP (BSKB)
We are pleased to announce the publication of . . .
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PM: Jeff Lupisella x225
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PRojeCt: BSKB-086 ‘14 Ad Design Edits
Run date: Jan 2014
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ContaCt: Hailey Lee, [email protected], 703.205.8000
VeR. : 1/2 page (7” x 4-3/4”)
Mod. date: 01.22.14 Wed 10:09 AM
LES Print Ad
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by Robert F. Reilly andPub:Robert
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Size: trim size: 7”x4.75”
Confidential: Information contained within this document is only intended for the recipient. Copying, distribution or communication of this document is stricly prohibited.
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This 700-page book, published in 2013 by the American Institute
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Robert Reilly and Bob Schweihs are managing directors
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MARCH 2014
Save the Date!
JOURNAL
JOURNAL OF
OF THE
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LICENSING EXECUTIVES
EXECUTIVES SOCIETY
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INTERNATIONAL
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MID-YEAR
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NEW YORK
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JOURNAL OF THE LICENSING EXECUTIVES SOCIETY INTERNATIONAL
2013 MEETINGS
Advancing and
Enhancing Business
Volume XLIX No. 1
Development,
Deals & Innovation
LES NOUVELLES
Advancing and Enhancing Business
Development, Deals & Innovation
les Nouvelles
March 2014
Advancing the Business of Intellectual Property Globally
Doug Kidder and Vince O’Brien — Page 1
Survey Results Confirm Growing Trend In Favor Of ADR
Judith Schallnau, comments by Russell Levine — Page 6
Patent Technology Landscapes For Assessing Intellectual Property
In Academic Environments
Joe Wyse, Ken Zinda, Greg Gerhardt, Bob Gregory and Eric A. Grulke — Page 15
Jargon, Term Sheets, and Documents
Louis P. Berneman and Christopher F. Wright — Page 25
The Exhaustion Theory Is Not Yet Exhausted: Part 3
Erik Verbraeken — Page 37
Louis P. Berneman, Todd C. Davis, D. Patrick O’Reilley and Matthew Raymond — Page 45
What’s Happening With Semiconductor IP Deals?
David R. Jarczyk — Page 50
Valuation Discussion Factors In Early Stage Software
Dwight Olson — Page 53
Biomedical Patent Securitization in Taiwan
Mei-Hsin Wang — 59
Recent U.S. Court Decisions And Developments Affecting Licensing
John Paul and Brian Kacedon — Page 72

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