For any new company, the last thing anyone wants to think about is litigation, especially litigation involving intellectual property claims. Indeed, as an IP Litigator, I am usually the last person in my firm that a start-up company wants to hear from or ever need. Recent surveys from the American Intellectual Property Law Association confirm that companies involved in IP litigation can face overwhelming legal costs, often running well over $1M per year of litigation. Such costs can cripple young companies during critical growth periods, often fatally. While there is no way to immunize your company from litigation, there are certain steps that can be taken to reduce the risk of litigation and minimize the sting if it does happen. However if your company is successful, the question is not if you will face a threat of IP litigation, but when. In this article, I provide some lessons learned from more than twenty years of representing companies in (often avoidable) IP disputes.
Craig Tyler, Partner Intellectual Property
Vinson & Elkins, LLP
1. Own and Have the Right to Use Your IP
I would estimate that about one half of the IP disputes I have litigated could have been avoided or at least minimalized with a thorough vetting of IP contribution, ownership and rights to use at the foundation or early stage of the company. In the early days of a company, usually the last thing anyone wants to do is to property vet (1) exactly what IP is being contributed and by whom, and (2) whether the company has a right to use that IP free from ownership claims from other people or companies. But if these issues are not vetted, they will certainly come back to haunt you after a company has become successful, and is engaged in a lucrative M&A or IPO opportunity. That is when past partners and previous employers tend to show up and hold the company hostage with ownership claims. And, even if there are no litigation threats, potential investors will conduct extensive diligence on your company to determine whether the IP they are buying is owned or licensed exclusively by your company. Any unanswered questions or threats to exclusive ownership and right to use will cost millions in price or may cause the deal to unravel.
Unfortunately, engaging and memorializing the necessary IP vetting is analogous to a prenuptial discussion and agreement, which no one really wants to have because it just dampens the excitement of the situation and brings in an air of possible distrust. That is why it is important to have an IP attorney ask the hard questions and vet the important ownership issues. It can be awkward for founders to vet these issues themselves, but an attorney can conduct such an analysis from an independent perspective. The attorney should examine founders’ contracts with previous employers or independent contractor jobs. Further, the attorney should assess potential claims by potential co-inventors or past investors with whom the founders worked. It is far less expensive to identify and rectify a claim by some uncle, cousin, graduate student or past investor at the foundation of the company when the technology is unproven and perhaps perceived to be valueless. If the issue doesn’t arise until that same IP is the foundation to company with a proven product that is about to go public, it will certainly cost much more to fix and may actually kill the deal.
Also important is to have clear assignments from founders of the critical IP, and to make sure that all employment contracts and independent contractor agreements have clear assignments of IP to the company. Under US law, most IP ownership vests in the individual inventor. Only by operation of contract can the company secure all rights to that IP. The company must have strong contracts in place to secure its exclusive ownership of the IP it is paying its employees and independent contractors to develop.
2. Memorialize Independent and Internal Development
Young companies move fast and there is a lot of excitement. Often slowing down enough to set up procedures to memorialize early research and development, much less set up an organized and structured source code repository, just falls too far down the action item list. Such tasks are often perceived to be big-company unnecessary formalities, and are left for some future date after a proof of concept is completed, a product is launched and the company can afford more employees.
But know one thing: if your company is accused of taking or infringing IP, a jury will see only three possibilities: you developed the IP yourself, you paid for it from someone else, or you stole it from the plaintiff. Thus, if your company cannot prove independent development or payment for its IP, the jury may conclude theft or infringement regardless of the facts. On the other hand, I have seen documentation and proof of independent development lead to early dismissals and low dollar settlement of IP claims that otherwise would have drug out for years and cost millions of dollars to defend.
So make sure that the technical team memorializes their work through dated logs and invention disclosures. Design documents should include revision dates. Also, make sure that source code is captured in a repository with version control. This proof of your company’s early work can be a valuable shield against future IP threats.
3. Be Wary of Emails, IM, and Social Media
Quite different from proof of early work and independent development, young companies are all too eager to create mountains of email, texts, blogs, and social media trails. Rarely will email or other informal communications prove useful in litigation. On the other hand, every litigator I know has more than one story about an email that has destroyed a case or client. Once email, IM, and other electronic communications are sent (and ultimately discovered in litigation), it will be difficult for the company to disprove whatever was said in those communications. Moreover, negative, derogatory, racist or insensitive emails can be used by the opposing party to discredit your inventor, founder or key witness in front of the jury.
Young companies must create a policy and training procedure for email use by company employees, for example, to teach them not to discuss former employers, competitors, or legal disputes in such electronic communications. Outside counsel can help develop such policies and training, and provide examples demonstrating the pain of not following such a policy. Employees need to understand how discovery works in litigation – even if emails are deleted they are still preserved on back-up tapes in a way that can be recovered in litigation. For every single email they draft and every post they make on social media, employees must remember that they may be in front of a judge or jury one day, with their family in the audience, explaining exactly what was meant by their email or post.
4. Do Not Allow Written Non-Privileged Assessments of IP Threats
What is the first thing that usually happens when a young start-up company receives a letter claiming of IP threat or infringement? It is emailed around the founders or executive team, and comments and quick assessments usually follow in response. Worse, an executive may forward the claim to the engineering team for their quick assessment or opinion. If done so without a lawyer involved, your company has just created valuable evidence for the plaintiff. And no matter how good your lawyer is, she’ll never be able to undo those uninformed initial comments from founders, executives or engineers.
Thus, executives must avoid assessing such claims in writing (email, memos, etc.) before counsel is involved. And given that many start-ups do not have in-house counsel, this can be a challenge. Further, many start-ups may want to see if they can handle the situation without the expense of counsel. This is a recipe for disaster, and such decisions usually result in significantly more legal costs in the long run. Once counsel is involved, however, the strengths and weaknesses of such threats can be assessed and a proper response can be prepared all covered under the attorney/ client privilege.
5. Do Not Ignore IP Threats
Many companies have a policy of ignoring IP infringement threat letters or offers to license, but this policy can backfire at trial. If a company ignores threats, the jury may believe the company engaged in infringement and did so willingly. Remember, the jury may not have an opportunity to see (or understand) evidence that the company receives such letters on a regular basis or that responding to all of them may be impracticable. Also, the plaintiff presents evidence first at trial and will use failure to respond to argue willful infringement or theft. Thus, your company should respond in writing to all IP threat letters in reasonable detail, with a reasonable tone, looking at each response letter as a likely trial exhibit.
Yes, it is true that responding to IP threat letters from a patent “troll” (e.g., patent licensing company) will cause that patent troll to want to engage in licensing discussions. And, yes, it is also true that some patent trolls will not follow up if your company simply ignores their threatening letter. They may simply go away. But what if they don’t? If a patent troll does decide to sue, those companies who completely ignored their letters will be the first to be sued because such facts provide the troll’s lawyer with the best story for the jury. Alternatively, the companies that first provided a polite response letter requesting more information to assess the threat and then, after assessment, politely declined a license as unnecessary but still wished the licensing company luck in licensing the patent are much less likely to be a litigation target.
6. Establish and Follow Employee Onboarding Procedures That Not Only Protect Your IP, But Also Prevent Improper Use of an Other Company’s IP.
Employees are the most common conduit for valuable IP leaving your company. For this reason, almost all companies create policies, training and agreements to safeguard the company’s IP from improper theft, use or disclosure. But these onboarding procedures should also include policies, training and agreement provisions that require new employees to safeguard the IP of their previous employer as well, and keep such third-party IP from infecting your company. The source of many threat letters and lawsuits claiming IP theft is the hiring of a key employee from a competitor. Evidence of your company’s onboarding procedures and policies for new employees will be at the center of such a dispute. Good evidence may stop the suit before it starts or at least lead to an early settlement. Lack of evidence, unfortunately, will invite the opposite result.
Your company must educate founders and new employees that the company wants nothing to do with IP belonging to a third party, and that employees are not allowed to use or disclose IP from previous employers. Onboarding procedures should train employees on a written policy and this policy must be followed. Onboarding of new employees should identify past confidential obligations, non-solicitation agreements and non-compete agreements, and secure the employee’s commitment to live up to promises made to past employers. Many companies believe that ignorance is bliss when it comes to past employers. But not only is such tactic risky, it also leaves the company with no positive evidence to counter a threat or lawsuit. A good plaintiff’s lawyer will use this to paint a picture of intentional ignorance that welcomes the use of third-party IP. If you want to be able to demonstrate that your company respects the IP rights of other companies, your company should (1) at least know at a high level, the obligations that its employees owe to other companies, (2) counsel the employees that they are to follow such obligations, and (3) make sure the employees understand that it is their obligation, and not that of the company, to ensure compliance.
Outside counsel can assist with the development of such onboarding policies and procedures. Such policies can provide useful evidence at trial that the company respects the IP rights of other companies. But, of course, if employees do not actually follow the policy in practice then that can make the company look even worse than if it was agnostic to the issue. So it is imperative to have good policies and procedures in place to insulate your company from exposure to other companies’ IP, and make sure such policies and procedures are followed.
7. Know Your Contracts
A contract for even a small project or short evaluation period may include intellectual property terms that could cause future litigation. For example, contracts often contain IP ownership provisions that are very one-sided and capture not only existing IP but all future related IP. Simple NDAs can create presumptions and include admissions that can hamstring your company. Start-ups are usually more interested in getting traction and deals, as opposed to spending time reviewing and negotiating contracts. This procrastination tactic unfortunately results in far too many start-up companies signing agreements (usually joint development or NDA with a partner) that cloudy up their exclusive ownership of or right to use key IP. Such agreements can derail a significant M&A event or IPO. Worse, such agreements create the uncertainty in IP ownership that leads to expensive lawsuits.
From simple initial NDAs to complex Joint Development Agreements, counsel should carefully review every contract that involves intellectual property prior to execution. Thought must be given to how the agreement may impact ownership and right to use current and future IP. And someone must know the entire landscape of the contracts entered by the company. For example, providing multiple partners an inconsistent “favored partner” status will lead to awkward disputes and even litigation. Similarly, entering into joint development or manufacturing agreements on overlapping technology with different entities can also land your company in expensive litigation. So don’t just get contracts signed to close deals, but be mindful of your contracts and understand your company’s rights and obligations under its contracts. It is shocking how many companies truly have no understanding of the extent of the promises and obligations they have made to other entities.
Conclusion
No one, specially a start-up, wants to spend time, effort, resources and money in litigation. But simply hoping that you don’t get sued is a poor strategy. Interestingly, Ben Franklin first used his axiom “an ounce of prevention is worth a pound of cure” to refer to fire safety and not health. In that vein, IP litigation can burn a start-up company to the ground with costs and attorneys’ fees. Fortunately, there are steps companies can take to minimize that threat. This article provides a few suggestions learned from 20+ years of IP disputes, most of which could have been avoided or minimized with a little more counsel and effort during formation and early stage. It is by no means a comprehensive checklist, but perhaps some of these suggestions might lead to lower litigation bills in the future. But just remember that the best intentions — just like ignorance – do nothing to prevent loss. Preparation does.