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So What Is the Problem With Intellectual Property Risk?
What do a small business software company, a privately held manufacturing company, a big box retailer, and a medical device company all have in common? Intellectual property risk.
“Intangible” versus “tangible” assets include intellectual property, which covers a diverse range of legally-protected rights such as patents, copyrights, trademarks, trade secrets, and designs, and other forms of intangibles such as human capital, contract rights and goodwill. In our increasingly knowledge-based economy, intangible assets have economic and strategic importance just like tangible assets such as real estate and product inventory. In fact, there is a silent war between “intangible” assets and “tangible” assets. Many would say that intangible assets are winning.
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Intellectual Property Risk
From the traditional risk management perspective, categorize intellectual property risk as both a first and third party risk.
From the first party intellectual property ownership perspective, the risks include the following:
- The legal costs of protecting and enforcing intellectual property rights
- The loss or diminished value of intellectual property as an asset, or diminished licensing or product revenues, as a result of legal findings of invalidity, unenforceability, or non-infringement, or challenges to title or ownership
From the third party intellectual property infringement liability perspective, the risks include:
- The legal costs to defend against an intellectual property infringement or theft suit;
- Any resulting settlement or damages costs;
- Design-around costs; harm to customer relationships; and negative impact on company share price.
Example of Pharmaceutical Companies
To illustrate several of these intellectual property risks, let’s look at the example of a generic pharmaceutical company challenging a name brand pharmaceutical company’s patent-protected drug through a paragraph IV ANDA and a lawsuit against the name brand pharmaceutical company’s patent on that drug.
The risk to the name brand pharma company is that the generic drug company will be successful in invalidating its patent by proving that the US Patent and Trademark Office should not have issued the patent to the name brand drug company in the first place. If this happens, then the name brand pharma company can keep selling its drug. But it can’t prevent the generic drug company from selling a drug based on the same compound at a much lower price. And, the patent asset’s value goes to zero.
The risk to the generic drug company is if it cannot prove that either the name brand drug company’s patent is invalid or that its drug does not infringe on the name brand drug company’s patent. If found to infringe, then the generic drug company must pay damages for any past sales of its infringing product. It must pull its infringing drug off the market or develop another, non-infringing compound on which to base the drug. Oh yes, and both sides will incur several million dollars in litigation costs in this process.
Minimize Intellectual Property Risk
There’s no quick fix, but the disciplined, integrated use of sound risk management practices will minimize intellectual property risk. This requires a coordinated approach by risk management, legal, financial, product development, and marketing to identify the risk, analyze it, and manage it. Who within a company should be responsible for managing intellectual property risk–Legal? Risk management? Product development? Marketing? Finance? Accounting? All of the above.
Is Insurance the Answer?
Insurance is not the only intellectual property risk management strategy. But it can be a key intellectual property risk management tool. The intellectual property insurance market is continuing to mature, despite some stops and starts. The global intellectual property market is on the increase, with some national patent offices creating and supporting intellectual property enforcement programs for their nationals. As underwriting processes and methodologies and policy forms are improved and actuarial data becomes more widely available, intellectual property insurance is expected to grow into a large, mainstream line of coverage, much like what has happened with D&O, E&O and product liability coverage.
Lloyd’s of London
Generally speaking, types of specialty line, stand-alone intellectual property insurance include: infringement liability; enforcement or abatement costs; reps and warranties, and first party loss or impaired value. Lloyd’s of London has been underwriting intellectual property risk for non-North American companies since the early 1980s. Some of its member syndicates are the most experienced global risk insurers.
After a five year hiatus, Lloyd’s of London, along with other London and US capacity, is back to providing intellectual property infringement liability coverage and intellectual property reps and warranties coverage to North American companies. These carriers offer claims made indemnity policies of up to $15+ million in limits for competitively priced premiums. There are also some US domestic alternatives, both stand-alone and as part of other types of coverage such as media, tech E&O, and cyber.
Infringement Liability Policies
Focusing specifically on infringement liability policies, the scope of coverage varies. For example, some markets require that the applicant obtain a freedom to operate opinion from an attorney. Then build the cover around the terms of the opinion. Others undertake their own due diligence and provide full coverage for products, processes or services sold or used by the applicant. More recent policies cover indemnities given to suppliers and licensees. This a very valuable extension for the technology community. Arrange territorial coverage worldwide. Policy terms are typically one year.
Such policies may or may not be duty to defend policies but most will include hammer clauses. Because insurers recognize that intellectual property litigation, particularly patent litigation, requires special training and experience, policy holders are frequently allowed to use their own intellectual property counsel in the event of a claim. However, most intellectual property infringement liability policies have a self-insured retention or deductible that must first be satisfied. In addition, a co-insurance percentage, which insurers may increase if an insured uses its own counsel, does not satisfy the insurer’s criteria or is not on the insurer’s list of approved counsel. The self-insured retention can vary from zero to several million dollars.
Submission and Underwriting Process for Intellectual Property
The submission and underwriting process varies depending on the type of coverage and the carrier. Some carriers use a staged process that provides a non-binding indication of terms to give potential insureds an idea of the limit of indemnity, self-insured retention, and co-insurance that would be offered and the estimated premium. If the potential insured goes forward with applying for coverage, then pay a nonrefundable underwriting risk review fee to the insurer before the insurer will accept the insurance application or perform its risk review. Other carriers require applicants to obtain a legal opinion and the carrier underwrites behind the legal opinion.
How Can Insurance Help?
Use intellectual property insurance for balance sheet protection, contractual liability protection and deal facilitation. For example, a software company with less than $2 million in annual revenue purchased intellectual property infringement liability coverage. But it also covers its larger licensees/customers. The annual premium was only $35,000.
As another example, a company was seeking to close a $60 million sale of a medical device product range to a large medical device company. A term of the agreement was originally drafted so that a $15 million retention (by way of escrow) was to be maintained for intellectual property infringement claims. This was proving to be a deal breaker until the transaction was saved by placing an insurance wrap for the intellectual property reps and warranties in isolation on a multiyear basis.
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