To the list of venues where intangible property has tangible asset value, add this one: The federal court system. Emboldened by Congress's creation in 1983 of what many lawyers have come to view as a patent-friendly federal appellate court, and by a 1996 Supreme Court decision giving judges more power to decide patent cases before sending them to juries, inventors and corporations are more willing than ever to take intellectual property claims to court. Also spurring the activity: a clutch of high-profile, high-stakes cases over the past decade, such as Polaroid v. Eastman Kodak, Honeywell v. Minolta, and Fonar v. General Electric, which have shown that intellectual property lawsuits can swamp balance sheets.
"As our economy becomes less manufacturing oriented, intellectual property becomes a much more important asset and represents a great deal of what shareholders have given a company to invest," says Christopher J. Steffen. A private investor and former vice chairman of Citicorp/Citibank NA, Steffen was chief financial officer of Honeywell in 1993 when that company won a $96 million judgment against Minolta for infringement of Honeywell's patented auto-focus technology for cameras. With that victory, Honeywell was able to wrangle licensing deals with other major camera manufacturers that netted it around $400 million in additional income, for a total of approximately half a billion dollars.
With consequences like that at stake, finance executives can't afford to leave the caretaking of intellectual property to their general counsel alone.
"It's very much a team effort, and the CFO has a role to play," says Jim Horstmann, chief financial officer of $90 million LaserMaster Technologies Inc., in Eden Prairie, Minnesota. "Especially at companies that can't afford to throw money at all their intellectual property, the CFO needs to work with the general counsel and some heavy-duty research-and-development people to pick and choose what they think is likely to be a product down the road and is defensible, and throw their resources at that."
Got a Million to Spare?
CFOs must discriminate in protecting intellectual property — trademarks, patents, brand names, copyrights, and trade secrets — because that protection doesn't come cheap. LaserMaster's operating subsidiary, ColorSpan, recently spent more than half a million dollars in legal fees to prosecute a trade-secret claim related to ink products it makes for its wide-format inkjet printers. ColorSpan alleged that privately held Sentinel Imaging, of Greenland, New Hampshire, had stolen part of its market for consumables by hiring two former ColorSpan employees who imparted trade secrets and customer information. The hefty legal fees it paid to prove that point didn't include the company's internal costs (principally executive time), which Horstmann says were "huge."
For its expenditures, ColorSpan won $2.2 million in damages last October after a jury agreed with its version of events — almost exactly two years after the suit was filed.
Sentinel is seeking to have that judgment set aside, and, while awaiting the judge's verdict, hasn't paid the money but has resumed sales of the consumable products over which the case was fought. While LaserMaster is mulling other legal maneuvers against Sentinel, its efforts so far have been extraordinarily costly for a company of its size.
"A run-of-the-mill patent case can cost $1 million," confirms attorney Ronald Schutz, who headed LaserMaster's case. Schutz is head of the intellectual property litigation department at the Minneapolis law firm of Robins, Kaplan, Miller & Ciresi LLP. For $1 million, a litigant can ordinarily expect the services of a law firm partner and a handful of expert witnesses. Longer and more complicated cases drive costs up rapidly. Contingency fees are relatively new to the intellectual property field and not widely used. Where they are, they can be quite welcome, especially when small companies take on large adversaries.
"Expansive patent cases can cost $10 million or $15 million," Schutz says. "There's a lot of lawyer time involved in understanding the technology and the prior art [previous developments in the technology] and analyzing the infringing product. There are often lots of documents involved, lots of depositions that need to be taken, and a lot of experts to be hired."
In a recent case in which a jury ordered six big oil companies to pay $69 million to Unocal Corp. for infringing on its patent for a cleaner-burning gasoline, Schutz's firm reviewed literally millions of documents. In the Honeywell case against Minolta, it had to review nearly a million documents written in Japanese.
While intellectual property litigation can be expensive, companies do have more options today in determining how to pay for that litigation. Trial lawyers once billed such cases almost exclusively on an hourly rate. But some firms today, including Robins, Kaplan, are now willing to take cases on a contingency-fee basis. When they do, the litigation tab can go sky high, typically starting at 40 percent of any recovery. Some lawyers will take a case on a sliding contingency fee scale — perhaps 10 percent of the recovery if the case is settled without initiating litigation, 25 percent if the case is settled before it goes to discovery (the stage at which lawyers begin taking depositions and interrogatories, and exchange information), 33 percent if the discovery stage is reached, and 40 percent once it goes to expert discovery. Still others will accept a discounted base fee, with a bonus for a successful result.
According to the Administrative Office of the U.S. Courts, patent litigation is a growth business. The number of lawsuits filed nationwide in the fiscal year ended last September was 1,840, a 25 percent increase over the number of filings five years earlier. The number of trademark lawsuits increased by 28 percent over that five-year period, to 2,925. While official data isn't yet available for 1997, litigators say the numbers continue to climb.
It hasn't always been that way. Prior to the 1983 creation of a federal appellate court to handle all intellectual property trial appeals, the majority of all patents challenged in court were found to be invalid, according to Barry Evans, head of the intellectual property practice at the New York law firm Whitman Breed Abbott & Morgan LLP. In some cases, courts were concerned about antitrust issues. In other cases, the application of patent law had simply lost any semblance of uniformity, since there was no central court charged with exclusive review of such cases. The new appellate court, located in Washington, D.C., brought a new measure of rigor and expertise to the field.
"The patent became invigorated, and companies began to litigate over intellectual rights and assets with the comfort of knowing that their rights would be enforceable and that damage awards would be there," Evans says. "It became good business to do so." Today, he says, a majority of patent infringement claims are upheld.
Patent holders won another victory in 1996, when the Supreme Court, in Markman et al v. Westview Instruments Inc. et al, upheld a federal circuit court decision that the interpretation of a patent claim (that is, the decision about exactly what a patent covers) is a matter to be decided by a judge before sending the case on to a jury. The practical result has been that judges now dismiss more patent cases on motions for summary judgment, before they go to trial. Obviously, that results in a faster disposition of some cases and lower costs for the parties involved — another incentive for companies to test the patent-suit waters.
Fonar Takes On GE
Fonar Corp., in Melville, New York, which was represented by Schutz and his colleague Martin Lueck, has been one of the winners in the new patent-law climate. Founded in the late 1970s by Raymond Damadian, the company created the first MRI (magnetic resonance imaging) machines to detect cancers and other diseases in the human body, yielding pictures far more accurate than X-rays. Fonar filed a number of key patents relating to its technology, but within a few years General Electric, Hitachi, and other big companies had entered the market.
After watching its annual sales plummet by tens of millions of dollars, Fonar sued both Hitachi and GE in late 1992, and sent letters to other manufacturers warning that they would be next. Hitachi settled out of court, but GE wouldn't budge. After litigating the case before a federal jury in 1995, GE was ordered to pay $128.7 million to Fonar ($110.5 million plus interest), a sizable sum for a plaintiff whose annual revenues today are only about $17 million. Late last year, the U.S. Supreme Court refused GE's request to hear an appeal, making the Fonar settlement one of the biggest patent-trial jury verdicts to be upheld by the courts.
Fonar CFO Lou Bonanni's involvement in the case centered on assessing the financial damages suffered by the firm. While assigning value to intellectual property is seldom easy, doing so in a patent case is at least defined by historical precedent. Almost invariably, the successful plaintiff's damages are calculated as either its lost profits (when it offers a product using the patented technology) or, at the minimum, a "reasonable royalty."
"Lost-profits damages are usually greater, but before you can get lost profits, you must prove that the patent owner could have made all the lost sales," says Schutz. In the Fonar case, the company argued that it could have sold all 600 of the MRI machines sold by GE during the period covered by the suit. GE argued that Fonar couldn't have sold any, while the jury concluded that Fonar could have sold 75. "So for those 75, we got lost profits [in this case, $371,000 per machine]," Schutz says, "and for the other 525, we got a royalty of $65,000 per machine."
Calculating lost profits is, in most cases, a straightforward accounting exercise. Determining a reasonable royalty rate is less exact. In the past, attorneys often hired retired industry "experts" to testify to fair value. Today, it is becoming more common to put accountants, economists, and other financial experts on the stand who can use economic models to suggest what a company might have agreed to pay, knowing its margins, in a negotiation for licensing rights to a patent.
"There also are circumstances where the damage award can be enhanced if infringement is found to have taken place," Schutz says. For example, in patent cases, which can be argued only in federal court, damages can be doubled or trebled, and the defendant can be held liable for the plaintiff's attorney fees and costs where the infringement is found to have been willful. Trade-secret cases are based on state law, and some states allow similar inflated damages.
Securacom Inc., a $14 million Woodcliff Lake, New Jersey, security systems vendor, tasted the bitter pill of inflated damages late last year when U.S. District Court Judge Dickinson Debevoise ruled that the firm had appropriated the trade name of a smaller Pittsburgh company, SecuraComm Consulting Inc., and then engaged in a "search and destroy" mission against it after the smaller company asked the larger firm to pay $275,000 to buy the name. The judge hit Securacom with treble damages totaling $2 million and ordered it to pay the smaller company's legal fees totaling $233,000. Securacom has filed an appeal, but has since changed its name to Stratesec Inc.
According to Kim Landsman, an intellectual property litigator at the New York law firm of Patterson, Belknap, Webb & Tyler LLP, companies seldom help themselves by taking unrealistic and belligerent positions. He advises litigants to be realistic in arguing the value of intellectual property, whether as a plaintiff or as a defendant, once it's been determined that that property was misused. Keep in mind the folly of trying to squeeze blood from a turnip; if a patent infringement isn't generating much revenue for the infringer, it's not likely to generate much in the way of monetary damages, even if you do prevail in court.
"At some point, there will be compromises and a splitting of differences, and it's a big mistake to come in with an exaggerated figure," Landsman says. "You lose credibility. My advice is to come up with an intelligently aggressive figure."
CFOs can take other steps to protect the value of their company's intellectual property. Jan Conlin, a partner of Schutz's at Robins, Kaplan, says that in addition to vigorously pursuing infringers, CFOs can steer their firms away from wholesale cross-licensing agreements. "If you are giving away a portfolio of patents to another business," she says, "you may have a hard time isolating a single patent later and trying to attach great value to it."
Even with a compelling case and solid evidence, however, courtrooms are tricky places to seek redress. "Any time you place a decision in the hands of a third party, you're taking a risk," Conlin warns. "And good businesspeople understand that both parties may be unhappy with the result."
Landsman also encourages CFOs to be mindful of their chances for success before racing to court. "Everything depends on the strength of your case," Landsman declares, "and the importance of the specific intellectual property in question can sometimes tear you in opposite directions." Suppose the intellectual property is extremely important, but the validity of the patent is weak. "On the one hand, you're loath to litigate because you don't want to lose on validity. On the other hand, you can't let the infringement go. That's where you're in the toughest quandary," says Landsman. When prospects of winning in court are high, going to court might still be less advisable than negotiating from strength before the litigation meter starts to run. "It's a very delicate call in any situation as to whether you write the cease-and-desist letter and then negotiate, or go right to court," Landsman says. "Remember, too, that in some circumstances, you may have some business relationship that could be jeopardized by suing somebody."
Adds Landsman, "If you have an intellectual property that is potentially extremely valuable, but you're concerned about whether the courts would uphold its value, pursue your rights very carefully," he says. "In cases like this, you may want to give infringers a graceful way to back down, rather than make them come after you and try to prove your rights invalid."
Finally, be prepared to be flexible when it comes to costs. "These cases are not the sort of things that can be religiously budgeted," warns Evans of Whitman Breed Abbott & Morgan. "You can try, but you'd better be ready to be disappointed. On the other hand, there is a certain amount of management that can be applied. There are a lot of flexible deals that companies are making with their outside counsel that make those attorneys partners in the outcome."
While an intellectual property lawsuit can be an expensive and emotional undertaking, often striking to the very heart of a company's business (consumables account for half of LaserMaster's revenues, for example), every indication is that more more CFOs will find themselves embroiled in such cases.
"As the caretaker of the corporate assets, the CFO must be knowledgeable in this area," concludes Steffen.
Randy Myers is a contributing editor of CFO.
Balance Sheet Debate
What IP lawyers say about putting the value of intellectual property on balance sheets.
As we have reported in the past, there is a movement afoot in some quarters of the academic, accounting, and regulatory worlds to have companies recognize the value of their intellectual property on their balance sheets. After all, the brand name Tide is probably worth more to The Procter & Gamble Co. than its headquarters building, to cite just one example. But only the latter shows up on the balance sheet.
Still, litigators who work the intellectual property field say there may be some perils to according intellectual property a tangible value outside the courtroom. Suppose, for example, a company puts a patent that it's not using on its books at a value of, say, $20,000. Now suppose that another company infringes on that patent to create a product with $1 billion in annual sales. Suddenly, it might be hard for the patent holder to argue in court that its patent is worth more than $20,000.
"This could just open up huge problems," says Ronald Schutz, head of the intellectual property litigation department at the Minneapolis law firm of Robins, Kaplan, Miller & Ciresi LLP. "I can just imagine the securities litigation that could come about if companies valued their intellectual property at X dollars, and had that value struck down in some future litigation in which it was trying to enforce its rights. The result would be an automatic shareholder lawsuit."
Christopher J. Steffen, CFO of Honeywell when that company prevailed in a major patent case against Japanese camera maker Minolta in 1993, says that case taught him a valuable lesson about the value of intellectual property, given that Honeywell itself didn't make cameras.
"It brought home to me," he says, "the realization that the value of intellectual property is what comes after it's been brought to fruition and put to work." —R.M.