It s Not Rocket Science, It s Insurance How to Use Insurance to Manage Patent Risk. Kimberly Klein Cauthorn Duff & Phelps LLC

Transcription

1 It s Not Rocket Science, It s Insurance How to Use Insurance to Manage Patent Risk Kimberly Klein Cauthorn Duff & Phelps LLC

2 I. Introduction The first bullet point on the cover of a brochure for a recent seminar on managing distressed intellectual property (IP) asks: If your competitors are financially distressed, what are the risks of their IP falling into adversarial hands? The weakened economy is causing increased uncertainty about who is selling IP assets, who is buying IP assets, and how such assets may be used. And, just as the recession is global, so is patent risk. During the last three years, more patent cases were filed in China than in the US. The number of patent cases filed annually in the US is holding steady around 2600 i ; however, the cost to litigate such suits continues to increase. ii So why should you care about IP insurance? Because with this increased uncertainty comes a greater interest by your clients in ways to decrease IP risk and ways to decrease the costs of managing their IP risk. This article identifies areas of IP risk, discusses types of insurance products that specifically cover patent exposures, and presents ways you can assist your clients in identifying the best insurance options for managing their patent risk. II. Patent Risk From the perspective of risk managers, insurance brokers and insurance underwriters, insurance policies address two sides of a coin: first party property ownership risk and third party casualty/liability risk. The commercial package policy is an example of an insurance policy that covers both sides of the coin. It contains the commercial building and property form, which addresses first party property risk such as damage to a building caused by fire. It also contains the commercial general liability form, which addresses third party liability risk such as physical injury to persons on the business premises as well as personal and advertising injuries such as slander and sometimes IP infringement. For patent risk, the two sides of this coin are the following: From the first party patent ownership perspective, some of the potentially insurable risks include: the legal costs of protecting and enforcing patent rights; 1

3 the loss or diminished value of the patent as an asset, or diminished licensing or product revenues, as a result of legal findings of invalidity, unenforceability, or non-infringement, some other type of governmental action, or challenges to title or ownership. From the third party patent infringement liability perspective, some of the potentially insurable risks include: the legal costs to defend against a patent infringement suit; any resulting settlement or damages paid to a third party for past infringement of the third party s patent; and patent infringement indemnification obligations to indemnitees such as distributors, customers, and licensees. From a first party direct or consequential loss perspective, the following may also be insurable: design-around costs to avoid infringement of a third party s patent; and lost revenue due to an injunction imposed as a remedy for infringing a third party s patent. There are a limited number of carriers that insure these patent risks. Some will insure patent-related exposures for non-us, but not US companies, or they will insure first party but not third party risks, or they will provide coverage only above a high retention point or only to companies below a certain size or will exclude companies in certain industries. Therefore, it behooves you to stay abreast not only of the different types of coverage available, but also of what the different insurance providers offer, to whom, and on what terms. III. Insurance to Address Patent Risk A. Understanding your Options In assessing available options, companies must be able to answer the following questions, which will be discussed in further detail in the remainder of this section: Is the insurance applicant seeking stand-alone patent coverage or patent coverage as part of other coverage, such as tech E&O? Some carriers, such as Darwin, may not offer stand-alone patent coverage, but they will offer some patent infringement coverage with their tech E&O policies. Is the insurance applicant seeking to cover open source software risks, such as contamination of proprietary software with open source code? Kiln, a syndicate in the Lloyd s of London insurance market, is the only carrier offering open source-related coverage for first party-related exposure. SAMIAN Underwriting Agencies Limited (SAMIAN), a specialist underwriting agency based in London, offers open sourcerelated third party infringement liability coverage as an endorsement to its IPGuard IP infringement liability policy. 2

4 Is the insurance applicant US domiciled or non-us domiciled? This is an important question because carriers offer different IP insurance options depending on whether the applicant is US-domiciled. For example, SAMIAN offers both IP enforcement coverage and IP infringement liability coverage, but the enforcement coverage is available only to non-us domiciled companies. Which side of the patent risk coin is the applicant seeking to cover? If the company is seeking property coverage for its own patents to protect against value impairing or revenue loss events, then it needs to purchase first party property coverage. If the company needs to fund litigation costs to enforce its patents against infringers, then it needs to purchase enforcement, offensive or abatement coverage. If the company is seeking liability coverage for claims of patent infringement made against it by others, then it needs to purchase patent infringement liability coverage but should understand the differences in the policy forms offered by carriers. If the company is seeking coverage specific to a contract or transaction, then it needs to identify which provisions require insurance coverage. For example, SAMIAN can provide coverage behind patent indemnification provisions in contracts through RepSure, its IP reps and warranties coverage, and as a contractual exposures endorsement to its IPGuard infringement liability policy form. If the company is seeking to cover multiple patent risks, then it may be able to purchase a multi patent peril policy from a provider such as IPISC. What is the amount of policy limits being sought? IPISC, for example, offers limits of $3 to $5 million, while SAMIAN offers limits of $15 million for US-domiciled companies. What is the company s size? Some patent insurance programs are targeted to sub $1 billion in revenue companies. For example, SAMIAN focuses on companies under $1 billion in revenue; however, SAMIAN will write patent infringement liability coverage for subsidiaries or divisions or for certain product lines of larger companies. For a survey report of available IP insurance coverage, go to Betterley normally performs an IP market survey every other year with policy synopses, contact information, trends, and product comparisons. In the fall of 2008, Betterley published its Intellectual Property Insurance Market Survey B. Bundled Coverage In response to the narrowing of the application of the advertising injury clause in the general liability policy form, insurance providers such as AxisPro offer separate media policies, some geared to media and entertainment companies, and some geared to non-media companies. These policies are typically written on a named peril basis for liability stemming from business activities such as production, broadcast, distribution, and advertising on and through any media or from the policy holder s marketing and advertising of its products and services. Examples of covered IP-related risks include: Copyright infringement; Trademark infringement; 3

5 Misappropriation of ideas not subject to copyright; Breach of implied contract relating to a third party s submission of a creative idea or other creative material to the policy holder; Sometimes theft of trade secret; Sometimes design patent infringement; and IP-related contractual disputes, such as breach of copyright or trademark license and breach of confidentiality agreement. Cyber-risk policies have sprung up to address activities in connection with an entity s content on the Internet as well as data breaches and losses. IP coverage typically includes: Copyright infringement; Misappropriation or unauthorized use of ideas under implied contract; Trademark infringement; and Piracy when directly related to copyright or trademark infringement. Some errors and omissions policies, especially for technology and software companies, provide coverage for IP infringement liability, including patent. However, these must be claims relating to the policy holder s professional services activities and the limits for patent infringement liability are generally in the $1 to $2 million range. Some policies, such as Darwin s Tech//404 product, offer a combination of media, E&O, and cyber liability coverage. The Tech//404 policy covers copyright, trademark, and limited patent infringement liability risk. Most of these policies exclude patent coverage, and all limit coverage to activities relating to the main purpose or focus of the policy. As a result, there is still a gap in coverage for patent risk. C. Patent-Specific Insurance Options 1. Background The Lloyd s of London insurance market has been underwriting patent risk for non-us companies since the early 1980s and its member syndicates are some of the most experienced global risk insurers. IPISC, a managing general 4

6 agency based in Louisville, Kentucky, has been offering patent coverage in the US since Some large carriers and reinsurers have, on a one-off basis, provided catastrophic coverage for patent infringement liability risk or provided excess coverage where patent infringement liability risk coverage is part of an integrated risk program. From about 1998 to 2002, Lloyd s, working with Litigation Risk Management, an IP risk consulting firm, and Aon s London office, provided patent enforcement and infringement coverage to US companies. During that time, AIG also offered a stand-alone patent infringement liability insurance product; in addition, Swiss Re offered a $25 million limit of indemnity patent infringement liability policy above a $25 million deductible to its larger insureds. In 2007, SAMIAN, a specialist underwriting agency based in London and focused solely on intangible asset exposures, began offering a range of IP insurance products to both US and non-us companies, including patent insurance. Its underwriting capacity is provided through several Lloyd s syndicates, other London and US insurance markets, and reinsurers. 2. Types, Terms, and Triggers As described more specifically below, types of patent insurance include: infringement liability; enforcement, also known as offensive or abatement; reps and warranties; first party loss or impaired value, and loss of revenue; and revenue loss due to an injunction. These coverages are sometimes bundled as multi-peril policies. They also often include coverage for trademark and copyright. a. First party offensive, enforcement, or abatement coverage reimburses approved litigation expenses incurred by the patent holder/policy holder in enforcing patent rights against infringers. This coverage can include trademarks and copyrights as well. In the US, IPISC offers this type of patent insurance. b. Third party defensive infringement liability coverage pays legal expenses and/or damages and settlement associated with patent infringement claims brought against the policy holder. Such coverage can be extended to include parties that the policy holder has indemnified for IP infringement liability claims. It can also be broadened to include copyright and trademark infringement liability. In the US, SAMIAN and IPISC offer this coverage. c. Reps and warranties coverage pays legal expenses and damages and settlement associated with the breach of patent-related reps and warranties made in the context of a transaction such as a sale of a business, products, technology, or patents. Covered reps and warranties can include title, infringement, and validity/enforceability. SAMIAN has written these policies. 5

7 d. First party loss of value or revenue coverage generally protects the insured from patent value impairment, loss of licensing revenue or covered product revenue as a result of invalidity or unenforceability of the patent or some government action that takes away a product s IP protection and therefore decreases product revenue. It can also cover lost product revenue due to imposition of an injunction against a company for patent infringement. IPISC offers this coverage as do certain Lloyd s of London insurance syndicates. Policy forms vary but are often written on an aggregate limit of indemnity basis rather than any one claim, using claims-made forms as opposed to occurrence forms. This means that for there to be coverage, the claim must be made during the policy period. Extended reporting periods can typically be purchased for additional premium. 3. Terms and Conditions of Coverage When advising clients not only on the availability of patent coverage, but also on the appropriate type of patent insurance to purchase, you should ask the following questions. This will avoid problems such as the client purchasing infringement liability coverage when the client s goal was to purchase insurance to cover litigation costs to enforce its own patent rights. In addition, because policy forms are not standardized and because there is a certain amount of negotiating of specific terms and conditions in which carriers are willing to engage, care should be taken to understand the key parts of the insurance contract: scope of the insuring agreement; definition of terms; exclusions; and conditions, especially regarding the claims approval and management process. What do you want to cover? First party, patent holder assertion of patent rights: What types of litigation costs are covered, i.e., assertion of patent rights, defense against declaratory judgment actions, and standard counterclaims such as invalidity, reexamination, or interference proceedings in the USPTO, arbitration, appeals? How is the patent to be defined and enforced? What about related patents such as continuations and divisionals and patent applications? First party, value of owner s patent assets: 6

8 Is there a formula for how the lost licensing revenue will be discounted? Will the lost value of the patent asset be pre-calculated? What are the triggers for coverage and what constitutes a claim when the patent is challenged or after it has been found to be invalid or unenforceable? Are financial valuation and legal evaluation of the IP by outside providers required as part of the underwriting process? Third party, infringement liability defense and indemnity: Does the client want blanket coverage for claims of patent infringement against any of its products or just for certain products that the client sells? Does the client want coverage for patent, copyright, and trademark infringement or just patent infringement? Is the purpose of the coverage to stand behind an indemnification provision being offered to a customer or licensee? Does the client want coverage for both legal expenses and damages or just one or the other? Direct loss due to imposition of injunction for infringing activity: Is the client s main concern the threat of an injunction? Will the policy cover both design-around costs and some percentage of lost revenue? Will the policy cover lost investment; for example, if a manufacturing facility can no longer be used because it was built exclusively to make the infringing product? Who do you want to cover? Depending on the nature of the transaction and the risk(s) being covered, it may be important for both the parent and subsidiary, the licensee, the licensor, sublicensees, distributors, or customers to be insureds or additional insureds or for the policy to be extended to cover the policy holder s contractual patent infringement liability indemnity obligations. What may not be covered (excluded)? Fraudulent, willful, dishonest, or criminal acts are generally excluded, as are damages resulting from such acts; trade secret coverage is often excluded. The cost of a going-forward license generally is not covered. There may be a number of exclusions relating to which products will be covered, which aspects of the products will be covered, and whether claims relating to certain specifically-identified patents or 7

9 companies will be covered. Certain related causes of action, counterclaims, and declaratory judgment actions may also be excluded. How far back do you want the coverage to reach? Note carefully how prior acts are defined because a broad prior acts exclusion can effectively gut coverage, especially coverage for patent infringement because the policy forms are typically claims made. For example, SAMIAN offers a damage calculation date that identifies the date on which the insured and the insurer agree that damages for the infringement accrue for purposes of insurance coverage, regardless of the actual damages accrual date. Also, enforcement policies are usually limited to "no known infringement" coverage, meaning the insured cannot already be aware of an infringer before purchasing the coverage. What is the geographic and temporal coverage being sought? Depending on the nature of the transaction and on the patents involved, the client may need territorial coverage beyond the US. For example, the client may want patent infringement liability coverage in every country where it makes, uses, sells, offers to sell, or imports product. Infringement liability policies are typically for one year. Reps and warranties policies and loss of value/revenue policies can have policy terms of up to three years. How much coverage do you want? If the client is purchasing coverage for contractual liabilities, is the limit of liability capped? If so, seek to purchase coverage up to that amount. If the client is purchasing enforcement coverage, estimate patent enforcement litigation costs and seek coverage for at least that amount. Bear in mind that different insurance markets offer different limits of indemnity. For example, Kiln offers first party loss of value/revenue coverage for limits of up to $15 million. IPISC typically offers limits of up to $3 to $5 million for its enforcement and infringement policies. SAMIAN offers limits of up to $15 million for policies placed on its US program. Other carriers are willing to provide excess coverage. How much risk are you willing to retain? The company must have a clear understanding of how much risk it is willing to retain. Nearly all patent policies require a self-insured retention (SIR) to first be satisfied. The amount of 8

10 the SIR varies widely from a few thousand dollars to millions of dollars. Infringement liability policies typically require at least a 5% co-insurance as well. 4. Triggers and the Definition of Claim Some providers, such as IPISC, will not allow claims brought within ninety days of the effective date of coverage. Other providers require notice of circumstances potentially leading to a claim, such as offer-to-license letters. Under the SAMIAN patent infringement liability policy, an action is not considered to have matured into a claim until some type of court action is initiated against the policy holder. 5. Submission Process, Underwriting Process, and Pricing a. Submissions To understand the submission process, it helps to first understand the insurance supply chain. Companies typically have a risk manager or someone else within the company responsible for purchasing insurance on the company s behalf. The person responsible usually retains insurance brokers to access insurance products offered by insurance providers. Examples of large, global commercial brokers include Marsh, Aon, Willis, Lockton, and Arthur J. Gallagher. Some of the larger, better known US commercial retail brokers include Hays Companies, HUB, John L. Wortham, Barney & Barney, and Woodruff Sawyer. Banks such as Wells Fargo have taken over smaller regional brokers and consolidated them under the bank s name in a separate retail insurance unit. Broker associations, such as TechAssure and Assurex, consist of regional insurance brokerage firms that do not compete with each other geographically and that often focus on clients in specific sectors such as technology and life sciences. US retail brokers that do not have wholesale or surplus lines licenses will sometimes work with wholesale brokers to gain access to insurance products. Some of the larger wholesale commercial brokers include Swett & Crawford, Crump, and AmWINS. US brokers with surplus lines licenses are required to access the Lloyd s insurance market. Authorized brokers communicate with specialist underwriting agencies or managing general agencies or sometimes directly with carriers to access insurance products backed by capacity provided by one or several insurance carriers. 9

11 For example, IPISC is an MGA with Gotham providing its supporting capacity. SAMIAN is a specialist underwriting agency with Lloyd s and several other carriers providing its supporting capacity. The patent insurance submission process is not standardized. However, generally speaking, the steps in the placement process are as follows: b. Underwriting Process 1. Submit completed application or at least sufficient information in order for the insurance provider to indicate whether they are interested in receiving a submission. A copy of the non-binding indication form for SAMIAN s patent infringement liability coverage is included in the Appendix to this paper as an example. 2. Receive indication from the provider as to whether they are interested; the indication may also provide premium and limit of indemnity ranges. 3. Provide detailed submission/presentation via a completed insurance application with information about the company and what the company seeks to insure, as well as requested exposures to be covered and limits. Some insurers require legal opinions and patent searches, and some insurers require payment of an underwriting fee. The SAMIAN patent infringement liability insurance application is included in the Appendix to this paper. 4. Allow the provider to conduct its due diligence and underwriting analysis. 5. Receive terms and conditions from the underwriter. 6. Negotiate terms and conditions. 7. Place the coverage. A policy specimen for SAMIAN s patent infringement liability coverage is included in the Appendix to this paper. The underwriting process varies depending on the type of coverage and the carrier. For example, some carriers require that the applicant share the results of a patent search or obtain a freedom to operate opinion from an attorney and then the insuring agreement is built around the terms of the opinion. Other providers, such as SAMIAN, have software tools they use to understand the patent landscape in a particular area and conduct all due diligence inhouse. Regardless of the carrier, expect detailed questions from the underwriters about: Patents; Products; Financials; 10

12 Competitors; Patent risk management policies and practices; and Patent dispute history, including offers-to-license and warning letters. While insurers continue to refine their underwriting methodologies and while their underwriting analyses may differ, all patent risk underwriters often consider the following to be red flags: Company is unable to provide a full inventory of its patents Company has no patents of its own and has not in-licensed patents to protect its products key market differentiators Company has received offer- to-license or warning letters Company has already been involved in patent litigation (this also can be viewed as a positive) Company is in the technology, medical device, pharmaceutical, or biotech industries (these industries are not necessarily off limits, but companies in these industries are more carefully scrutinized) Company is a threat to the market leader and has no patents on its products and the market leader owns a large patent portfolio c. Pricing Premium is usually calculated on a rate-on-line basis. For patent policies, premium rate-on-line can range from 1%- 10%. As an example, 1% rate-on-line for a limit of indemnity of $1 million would be payment of a $10,000 premium. Typical price deflators/inflators are: amount of risk the applicant is willing to retain; co-insurance percentage; applicant s industry; length of time insured products/technology have been on the market; size of the company; number of products or patents to be insured; claims history; market dynamics; strength of applicant s patents. As more policies are placed and as more carriers enter the patent insurance market, the pricing will likely decrease. D. Claims Submission Process Make sure your client understands policy requirements for claims approval and claims management. For example, for enforcement policies, the insured's counsel may need to provide claim charts, and the insurer may require some type of evaluation of the claim. For defensive/infringement liability policies, the insurer may require a legal opinion 11

13 of non-infringement. A financial valuation of the claim may be required for first party policies that protect against loss of patent asset value due to events such as a legal finding of invalidity. Typically, the insured may select counsel. However, choice may be limited to selection from a list of approved counsel or to counsel meeting certain criteria or counsel may be subject to insurer approval. For example, SAMIAN will generally allow the insured to select counsel but will subject the insured to a higher SIR and higher co-insurance percentage if selected counsel is not on SAMIAN s list of recommended counsel or does not meet SAMIAN s criteria. The insured and its counsel are typically required to communicate with the insurer on a regular basis, including the provision of written reports. Settlement requires the insurer s consent. E. How to Use Patent Insurance IP insurance can be used strategically for balance sheet protection, contractual liability protection and deal facilitation. Typical scenarios include the following: Negotiation of contracts such as licenses, distributor agreements, OEM agreements, and joint development agreements where patent infringement liability indemnification is an issue or patent insurance is required iii ; In M&A transactions where the purchaser is looking for protection from potential patent exposures; In M&A transactions where the seller is looking for relief from burdensome reps and warranties, escrow, or indemnification requirements; Company is rolling out a new product line or entering a new geographic market. IV. Conclusion In analyzing whether to purchase insurance as a way to transfer any or all of the risks identified in Section II above, there are several points to consider: First determine whether the company already has coverage under existing policies and, if so, whether the coverage and policy limits are sufficient. Understand the nature of the risk the company is seeking to cover. Insurance is intended to cover fortuitous risk, not a reasonably foreseeable business risk. Nor is it usually intended to cover a risk that is already an issue, such as existing patent infringement litigation, known infringement of the company s patents, or an offer-to-license letter. Don t wait until the house is on fire or someone has already struck a match. 12

14 Clearly understand the risk and seek coverage tailored to that risk. For example, if the company s concern is the threat to its balance sheet posed by patent infringement litigation against it, then seek defensive third party patent infringement liability coverage, not offensive first party enforcement/abatement coverage. Balance the cost of the coverage in terms of time spent gathering the information to provide to the carrier and negotiations with the carrier, fees paid to insurance brokers or consultants to assist with preparing the insurance submission and negotiating coverage, underwriting fees paid to the insurance carrier, the premium, and the self-insured retention and any co-insurance against the benefits to the company of transferring the risk. However, bear in mind that the premium is often no more than the first month s bill from litigation counsel to defend a company against a claim of patent infringement. The insurance industry is re-focusing its attention on patent risk and the products it can offer to transfer such risk in the same way the industry has addressed product liability, environmental, employment practices liability, directors & officers, errors & omissions, and other commercial risks. You are doing a disservice to your clients if you do not apprise them of available patent insurance products. ii According to the Stanford IP Litigation Clearinghouse, the average number of patent suits filed annually between was ii According to the AIPLA Report of the Economic Survey 2007, each side can expect to spend $ million in a mid-sized patent case. iii Increasingly, companies in the large retail, financial services, telecommunications, and technology spaces are requiring their vendors and suppliers to carry patent insurance. 13