Account of profits against non-combatant defendants

An extempore decision of Mr Justice Vos (Chancery Division, England and Wales) last month addressed the question of whether it was appropriate for an IP owner to seek an account of profits against an alleged infringer who takes no part in the proceedings at all. This decision, Pfizer Incorporated v Mills and others (10 May 2010), arose from a claim by Pfizer that the defendants had infringed one of its registered trade marks by passing their products off as Pfizer's [from this note, taken from LexisNexis Butterworths, it's unclear whether the action was for trade mark infringement, passing-off or both]. Pfizer obtained search and seizure orders requiring disclosure of relevant materials, then in May 2009 issued and served a claim form. The particulars of claim were served on the defendants, after some difficulties, in November 2009. In March 2010 Pfizer applied for judgment in default of acknowledgement of service or defence, seeking, among other things (i) an enquiry as to damages or an account of profits and (ii) payment on account, under Civil Procedure Rules r25.7(i)(b), of 75% of the defendants' estimated profits.

Vos J felt that the best course for Pfizer was to elect an account of profits. Since earlier disclosure orders had not been complied with, it was inappropriate for the court to make further orders of that type. Regarding the claim for an interim payment, Pfizer's 75% calculation was a fair one, which gave the defendants the benefit of the doubt. Since Pfizer belonged to a substantial international corporation -- which would be able to repay any excess should the amount eventually assessed be lower than anticipated -- any overpayment could be compensated. For these reasons, and since the defendants were the authors of their own misfortunes, the claim for payment on account of 75% of their estimated profits was fair.

How much should you invest in patents?

How much should you invest in patents?” ask Kelce Wilson and Claudia Tapia Garcia in a recent edition (XLV, No. 1) of the Licensing Executives Society journal LES Nouvelles. The authors are Senior Patent Attorney and IPR Counsel at Research in Motion, makers of the BlackBerry smartphone.

“Should you spend more, spend less, or keep things constant?” they ask, noting that “Only a few organisations have a system for objectively evaluating whether they are allocating the right amount of funding. Unfortunately, most seem to be at risk for spending either too much or too little on IP protection.”

In the same way that economic theory suggests that the optimal market price is to be found at the intersection of a supply curve with a demand curve, the authors suggest that the optimal IP protection budget can be found at the intersection of “Value” and “Effectiveness” curves.

According to the article, the Value curve represents “the actual economic value achieved by reducing the risk of IP loss”. The authors suggest that an IP owner should be able to identify the economic value associated with a given level of risk reduction by analysing the expected impact on profits, brand image and other business or marketing considerations. They note that the value assigned to a particular risk reduction target is the money that the IP owner would be willing to pay to achieve that target.

The Effectiveness curve corresponds to the actual costs incurred in achieving a given level of risk reduction and is determined empirically. “For example, patent applications filed for a moderate cost may be shown to deter infringement by most small competitors, but perhaps not large competitors that are willing to devote sufficient resources to attempt invalidating the patents” the authors note. “However, if a greater amount were to be spent on patent application preparation and prosecution, the resulting patents could have a higher quality that is sufficient to deter even large, well-financed competitors”.

The devil is in the data – how does one quantify, for example, the extent to which low cost applications deter small competitors? No such data is contained in the article. Nevertheless, this “Protection Valuation Tool”, as it is called, does represent another way of looking at the IP cost/benefit question that may be easier for investors and financial directors to understand.

IP valuation: don't underestimate the endowment effect

IP Valuation is not an exact science and the cold rationality of classical economics often fails at giving a value to items of Intellectual Property that satisfies owners and buyers equally. In the specific case of standard-essential technology for instance, it often appears that owners of patents cling on to them with iron claws and will not license it unless the benefits of the transaction largely outweigh the cost of divulging the technology. However according to Prof. Christopher J. Buccafusco (Chicago-Kent College of Law) and Prof. Christopher Jon Sprigman (University of Virginia School of Law) IP law is still largely governed by the rational choice model, which "posits that, when making decisions, people rationally weigh the utility they will derive from different choices and assign monetary values to the options based on the anticipated utility these choices will provide". The two professors decided to call this assumption into question by applying the findings of the behavioural research to the field of IP, as it was clear to them from the beginning that IP owners aren’t more rational than any other individual engaged in a transaction. Their article entitled "Valuing Intellectual Property: An Experiment" (download here) reports on the results of an interesting experiment they carried out in order to determine if IP transactions are subject to the endowment effect, which is the most important contribution of the behavioural research in the field of economics.

“A mountain of survey and experimental data have shown that people attach substantially higher value to goods if they own them then if they are considering purchasing them. People are reluctant to part with their property, and the amount that they are willing to accept (WTA) to sell it generally far exceeds the amount that others are willing to pay (WTP) for it. This WTP/WTA gap has been termed the “endowment effect,” and it has been detected for an astounding variety of forms of property."

As Buccafusco and Sprigman asserted, the endowment effect seriously eroded the “sacrosanctness” of the rational choice model and also had repercussions on many areas of law (such as tort, contract or tort, contract, property, and criminal law).They realized nevertheless that IP law has been relatively immune to this groundbreaking finding of the behavioural research and decided to set things right. Their experiment is all the more interesting so as IP goods are actually created by the owners and are non-rival (their consumption by one person does not prevent their consumption by another). Moreover their experiment – based on a market for poems – is the first one to ask subjects to actually create an object and then value it.

Not so surprising yet quite thought-provoking, the results of Buccafusco and Sprigman's experiment prove that actors engaging in an IP transaction are only "boundedly rational", much like in any other transaction environment. They surely are utility-maximisers, however the preferences on which they based their decisions are very unstable instead of being a constant, as the rational actor model assumes. Their experiment also showed that the difference between WTA and WTP is even higher than expected, even though poems are non-rival goods.

“Our findings suggest that private transactions in creative goods may face significant transaction costs arising from cognitive biases that drive the price that creators and owners of IP are likely to demand for transfers considerably higher than what buyers will, on average, be willing to pay. This does not mean, of course, that transactions in IP will not take place – we see such transactions happening out in the world every day. Our research suggests, however, that IP transactions may occur at a level that is significantly suboptimal and that the baleful effect of cognitive and affective biases is likely to be more serious for transactions in works of relatively low commercial value, or for which no well established custom or pattern helps to inform valuation.”

The result of this experiment could have far-reaching implications in the field of IP transaction and calls for more research on other types of IP goods, notably in the case of patents. It could be argued for instance that due to years of R&D - which are intense and costly all of points of view - the sense of ownership of scientists and researchers toward their inventions is probably exacerbated and higher than in any other field of IP. If this hypothesis were correct, the transaction costs related the licensing of a patent would be much higher than expected and would drive down the overall level of patent transactions significantly.

From Bonds to Bond? Investing in film futures

I premise my following comments with a caveat: I am not much of an expert on the economics of futures, derivatives, hedges and the like. Stocks and bonds have provided enough excitement for me over the last few years; I leave the more exotic stuff to experts, the likes of AIG and Lehman Brothers.

Against that backdrop, an item in the April 24 issue of The Economist, entitled "Box-offce futures: Land of the Lost", caught my eye. The article discusses the approval that has been given by the U.S. Commodity Futures Trading Commisison (CFTC) for two exchanges (one to be administered by Cantor Fitzgerald, the other by Media Derivatives) that would allow trading in contracts that are based on the box-office take from films. The second of these exchanges was approved by the CFTC on April 20.

The appearance of these exchanges can be seen in the light of a perceived problem in Hollywood about how to better to spread risk. It seems to be that, akin to judicial notice, Hollywood has for a long time tended to rely on a small number of box-office hits to both cover the losses incurred by the majority of films, as well as to provide a net overall profit for the studio. This business dynamic, risky in its own right, has been exacerbated by the economic meltdown of recent years. Individual investors have not flocked back to finance films. As well, independent film makers (apparently being other than the six major studios) are finding it much more difficult to sell in advance rights to sums received from foreign box-offices. This appears to have been their preferred means in the past for funding their pictures. But this funding window is much more narrow these days.

However, while the exchanges have been approved, no contracts have been traded and the studios are actively engaged in stopping the exchanges dead in their tracks, both directly and through Congress. As such, they have ramped up their lobbying activities agains the operation of the exchanges. As for getting Congress to focus to enact a legislative ban against box-office futures, one needs to ask how successfully this issue can be pushed in light of the broader Congressional program to reform regulation of the financial markets. Within Congress, opposition has brought together strange bedfellows, including Senator Barbara Boxer, a noted liberal senator from California (who is also, I think, involved in a reelection campaign that might include making nice to Hollywood), and noted conservative Senator Orrin Hatch from Utah.

Hollywood to the rescue?

What are the arguments against the operation of these exchanges? Let's mention several as discussed in the article:

1. Box-office figures are merely estimates and so, presumably, cannot be relied upon. Whatever the accuracy of this metric, still they must certainly be galaxies more precise than either the AAA bond ratings given in connection with subprime financial instruments or Greek fiscal data. On the other hand, one should not dismiss out of hand the impact of the uncertainty of the underlying metric in questioning the effectiveness, if not the very viability, of such an exchange. As Frank Knight taught us nearly a century ago, risk is one thing, uncertainty is quite another.

2. There is an information imbalance in the film business. A study carried out by Thomas Gruca of the University of Iowa found that there was an average error of 31% in predicting revenues. That said, there is a severe assymetry of information between the studios and other investors. As for the studios, they presumably have pre-screening insights gleaned, from contact group viewers, as well as knowledge about marketing plans and budgets and how the film will be rolled out. In the words of The Economist, "almost every trade by a studio would be an insider bet."

3. Studios would never short their own films via trades on the exchanges. The reason for this, as suggested by the article, is that Hollywood moguls can never be seen as somehow acting in a way that undercuts its own persona of success and power, much less affecting the possible commercial success of its films.

Assuming that the studios have their way and the exchanges never get off the ground. The question still remains: is there a better way for them to hedge their risk? Or is the old way also the new way for hedging risk? After all, events of the last three years have shown that one should exercise a healthy skepticism before adopting the latest offering of finanical innovation.

Proposals for CFCs: how will they affect IP?

The IP Finance blog thanks Andrew Clay (Head of IP, Hammonds LLP) for drawing his attention to Proposals for controlled foreign companies (CFC) reform: discussion document, a document published by Her Majesty's Treasury and Her Majesty's Revenue and Customs in January 2010. Writes Andrew:

"I do wonder if the section on IP (section 4) shouldn't receive wider attention as these are clearly proposals that could, if implemented, impact on a lot of the IP shuffling that many businesses and their advisers will have an involvement with".

The document, 35 pages in all, invited comments by 20 April. However, with the change of government, it may be that late submissions will still be seriously considered.

You can read the proposals in full here.

Note: after posting this, my learned colleague Anne Fairpo reminded me that she has already posted on this very topic here. However, since IP Finance has so many more readers now than it had at the end of January, we've decided to leave today's piece up for the benefit of those readers who missed the original.

Employee inventions and flat-rate compensation in Austria

An article entitled "Flat-rate compensation for patentable employee inventions", contributed by Ferdinand Graf (Graf & Pitkowitz Rechtsanwälte GmbH) to International Law Office, discusses an Austrian Supreme Court decision in August of last year (9 Ob A 39/08p) in which the Court gave its opinion as to the validity of flat-rate compensation agreements for employee inventions.

In short the claimant, a retired employee, had invented during his employment a compressor to be used in his employer's business. The employer secured patent protection and then insisted on flat-rate compensation, the claimant having to waive his right to further compensation. In a subsequent action the claimant sought adequate remuneration, arguing that, inter alia, (i) a change in circumstances entitled him to additional compensation and (ii) the waiver was invalid according to Austrian law.

Under the Austrian Patent Act, employees (if not specifically employed for the purpose of making inventions) are entitled to adequate compensation if their invention -- or any right to use the invention -- is transferred to the employer. The agreed compensation can be adjusted (both in advance and retrospectively) if the compensation is rendered inadequate following a change in circumstances, so long as the employee is not required to repay any compensation received.

The Supreme Court, disagreeing with the Appeal Court's view that such agreements were null and void, said they were enforceable, but subject to adjustment by the courts. Payment of a flat rate can actually be advantageous for the employee, who immediately receives greater financial funds to dispose of and need not suffer any diminution in compensation if the invention drops in value later on. Thus, compensation for employee inventions may be effected either by periodic payment (licence fees) or by a single lump-sum payment.

Even though the claimant waived his right to claim further compensation, this waiver was invalid and did not affect a retrospective adjustment of the compensation. Adjustment of the amount of compensation is also permissible if the employee knew of the true value of the invention when concluding a flat-rate agreement or accepting a waiver, but could not provide sufficient evidence for that assumption. The amount of compensation will reflect the value of the invention and is to be computed on the basis of the economic significance and other relevant aspects of the invention. If the invention is at least of some internal economic relevance for the employer, compensation in the amount of what is proper in the individual case must be paid (cost benefit analysis).

The author of this note observes that the employer is at risk of extensively using an invention for which it has paid a flat-rate fee, only to find out later that, by way of a retroactive adjustment to the employee's benefit, the use turned out to be more expensive. Such a circumstance is particularly troubling for the employer if - as in the present case - other non-patented technical alternatives were available for use.

Reputations and bottom lines: a new book

Intangible Capital: Putting Knowledge to Work in the 21st-Century Organization, by Mary Adams (right) and Michael Oleksak, has now been published and is available via Amazon at US$34.95. This is a project from I-Capital Advisors, which occupies a vocal corner of the IP finance world. According to the web-blurb:

"Today, 70% of corporate value is in intangibles. This is most clearly seen in mergers and acquisitions activity but is actually true for every company This value comes from knowledge that is developed by people and turbocharged by IT. But because our management systems and accounting are still based on industrial-era customs, this value remains invisible, misunderstood and unrecognized.

We have been successful in helping our clients use intangible capital tools to negotiate with merger partners, gain financing, improve performance and build the value of their companies. In early 2008, as we began writing about what we saw as the coming recession, we knew that it was time to take our IC message to a larger market. That fall, we sold our book concept to Praeger and during the dark days of the recession we worked on the manuscript, hoping to contribute to the recovery ...".

The book is described as "a practical handbook for every manager struggling to succeed and innovate in today's knowledge-based economy. It explains why intangibles are critical to performance, value and innovation. Why reputation is the new bottom line. And why intangible management skills and tools are critical to the future of your business".

Intellectual property tax havens: where's best?

Another reader has asked this weblog, in general terms, which jurisdictions are regarded as the best tax havens for intellectual property portfolios. In particular, he wants to know, are there some countries which are good places in which to place some types of IP but not others?

If readers have any suggestions, can they post them as comments below.

IP Valuation Courses: some responses

Last Friday, in "IP Valuation Courses: a reader asks ...", this weblog posted this request for information:

"A reader has emailed IP Finance to ask if it knows of any courses on intellectual property valuation that are (i) general, in the sense of not being specific to any one type of IP right or market sector, and (ii) general, in the sense of being at a high enough level to be understood by someone who is not an accountant or a financial whizz-kid but who needs to be able to identify the main issues and thus be equipped to follow the general thread of what accountants and whizz-children tell him.

If you know of any such courses, please let me know. Also, if you think you could help in putting such a course together, please say so."

From Chris Bartlett, until recently Senior IP Valuation & Contracts Manager at Glasgow-based ITI Techmedia and currently Chair of the Education Committee of the Licensing Executives Society (Britain & Ireland), comes this response, which both poses a question and provides some information:

"I do know that there are a number of dedicated IP valuation courses available in the UK, but in my experience these can be very sector specific, typically healthcare and pharma, and also generally assume an audience sufficiently experienced in the general IP field that they now have a wish to look at valuation methodologies as a fairly detailed specialist area.

I am not aware of any single course which fits your criteria though I would certainly be very interested in working with others to create one - indeed building such a course fits within my present strategy for new LES courses in the UK.

In the meantime, perhaps you may like to inform your readership of the forthcoming LES Fundamentals of Intellectual Asset Management course at Cranfield in June, in which valuation at precisely the pitch your reader desires is presented within a broader context of intellectual property and asset management as a whole. Details can be found here.

I would welcome, perhaps through the medium of your blog, proposals from suitably qualified practitioners to provide both content and their presentation skills for provision of a one day course-cum-workshop targeting IP valuation for non-IP specialists, managers and IP newcomers".

If anyone wishes to contact Chris regarding his invitation, can he or she please email him here.

The IP Finance weblog has also received details of this course from the Business Development Academy which, we learn, has been taught all over the US, UK, Europe and Israel and that over 200 representatives from Fortune 1000 businesses have attended the course.