Magazine Article | March 9, 2010

What Corporate Directors Need To Know About Intellectual Property

Source: Life Science Leader

By Barry Marenberg, Esq.

In many companies, intellectual property is something simply left to the lawyers. While the number of corporate board members who pay attention to IP has increased over the years, oftentimes IP issues are relegated to the bottom of the agenda at board meetings — if they are on the agenda at all.

According to recent estimates, in the United States, patents and related IP assets account for $1 trillion in value. With numbers of this stature, the board of directors, composed of corporate board members who are charged with managing a company’s business and affairs, cannot ignore the importance of their company’s IP. Relegating IP issues to the bottom of the agenda (or not dealing with them at all) is a serious mistake in this day and age of corporate accountability.

Amongst numerous legal reasons, the Sarbanes-Oxley Act (“the Act”) renders IP extremely significant to corporate officers and board members. The Act imposes several requirements upon the principal executive officer and principal financial officer or persons performing similar functions. Section 302 (S302) of the Act requires these parties to certify that annual or quarterly reports do not contain any untrue statements of material facts or omit a material fact necessary to make the statements in the report not misleading. In addition, S302 requires the executives to certify that the reports “fairly present in all material respects the financial condition and results of operations” of the company for the periods presented in the report. In addition to the corporate responsibility for financial reports imposed by S302, the Act also requires management assessment of internal controls in S404 and establishes criminal penalties in S906 for failure of corporate officers to adequately certify the content of periodic reports.

The Act requires disclosure of important company assets in the business section; generally some type of IP should be considered in this category. Clearly, for a life sciences company, the value of an intangible asset, such as a patent or a bundle of licensing rights, is central to appraising the company’s worth. This requirement is not only of concern to companies that rely nearly exclusively on technology; other examples of valuable intangible assets frequently overlooked include customer databases and unique customer interfaces employed by financial service companies, as well as trademarks and domain names.

In addition to disclosure of intangible assets, the Act also requires identification, measurement, and disclosure of risks that could result in unreliable financial disclosures. Once again, the inherent nature of IP assets often makes this an arduous and perplexing task. It is often difficult to determine if the risks relating to the use and protection of the company’s IP could result in unreliable financial disclosures, especially for companies that are not primarily focused on technology. Some obvious examples of an IP-related risk which must be disclosed are material litigation with respect to the IP portfolio or an interference or reexamination proceeding concerning a patent central to the business operations. Other risks which are not so obvious but may nevertheless need to be disclosed include upcoming expiration of IP rights the company owns or licenses from others or loss of exclusivity privileges of IP rights owned by the company.

Balancing Disclosure Obligations And Fiduciary Duty
Making this disclosure even more difficult are the inherently inconsistent obligations created by the Act. Often, the value of IP lies at least in part in its secrecy (e.g. the secrecy of an invention in a patent application prior to its publication or the choice made by a company to retain an invention as a trade secret). However, the corporate officers must follow the disclosure requirements of the Act with respect to material risks of financial unpredictability in all periodic reports. These disclosures are required if they assist investors in evaluating the company or have a potential financial impact. Corporate officials face a significant challenge in balancing the disclosure obligations against the fiduciary duty to preserve asset value, magnified when that asset value may be diminished or destroyed by disclosure. This requirement of corporate officers to fulfill inconsistent responsibilities demonstrates how difficult it is to successfully walk the line in the Act’s IP arena.

In addition, the board or individual directors need to ascertain that corporate management satisfies the requirements under the Act; corporate directors cannot ignore their own oversight activities. While the “business judgment rule” prevails, such judgment must result from being properly informed. The paramount consideration is that the board ensures that it is appropriately informed and that the board, in turn, ensures or oversees the appropriate reporting of the information as legally required.

Further, under the “duty of good faith,” a corporate board and its individual directors must act in good faith to monitor the company’s IP. Coincidentally, the certificate of incorporation of most Delaware corporations indemnifies directors from personal liability under Section 145(a) of the Delaware General Corporation Law. However, that section permits indemnification only for actions made in good faith, and Section 102(b)(7) specifically prohibits corporations from limiting or eliminating liability “for acts or omissions not in good faith.”

The Board’s Duty To Manage IP
While board members certainly do not want to usurp the privileges and freedom of senior corporate officers nor engage in nitpicking oversight of the IP function, the board does have a fiduciary duty to devote sufficient oversight to the management of IP assets. The primary focus of directors should be the thoughtful and appropriate oversight of management. IP should be subject to regular board oversight, in the same manner as critical financial, tax, or other issues. Directors should understand the fiduciary obligations of care, loyalty, and good faith to the corporation and its shareholders and also take the time and effort to provide the necessary oversight of management. Boards should seek counsel to ensure a good process occurs and is appropriately documented. Finally, in the context of IP oversight, directors should regularly review the company’s IP assets and related IP strategy as benchmarked against industry practice, engaging qualified counsel and other technical professionals to assist in the evaluation and protection of IP assets.

Corporate law regarding directors’ duties is driving the need for greater board-level and officer education about IP. A 2006 decision by the influential Delaware Supreme Court found that directors can be subject to oversight liability for failing to implement a reporting or information system that protects corporate assets and for failing to oversee the operation of that system. Furthermore, the court defined this oversight failure as a breach of the duty of loyalty (not the duty of care). As a result, directors can be held personally liable for IP mismanagement.

Steps To Reduce Regulatory And Litigation Risk
Corporate waste occurs when assets are used for an improper or unnecessary purpose, when an exchange of assets is very one-sided, or where assets were “irrationally squandered or given away.” The business judgment rule also does not insulate directors from claims of corporate waste. A few steps can help directors ensure that their company’s IP is properly managed and that regulatory and litigation risks are mitigated. It would appear self-evident that sound IP management can enhance internal controls and reduce regulatory and litigation risk.

Companies should start by assessing (at least annually) their current IP-related controls, and performing an IP risk assessment. This includes evaluating internal information flow and the transparency of the existing IP program, assessing processes, and performing risk and opportunity analyses. A risk analysis could determine, for instance, whether more protection for IP is necessary in the United States or in foreign countries, while an opportunity analysis would examine the IP portfolio and current industry trends relevant to the exploitation of IP.

At least annually, companies should also develop and document internal IP controls. Of course, any procedures that are established for IP identification, measurement and management, control, and compliance must be implemented to be effective. The controls should provide management with information to make good decisions about IP protection and commercialization. Not only will these steps reduce legal risk, they also should lead to improved IP asset management and financial performance.

In addition, directors should actively review the terms of their company’s directors’ and officers’ liability insurance policy, preferably with the assistance of counsel. Directors should also consider personal insurance policies. In today’s environment, the potential risks to directors are simply too great either to ignore these risks or not to implement some type of policy to protect directors against such risks.

Stay Informed Of IP Strategies
As previously noted, corporate directors must be aware that they have a fiduciary role in the oversight of a company’s valuable IP assets, as well as an understanding of the associated risks. A corporate director must be adequately informed about and involved in the company’s IP strategy. Just as directors must understand the other drivers of corporate performance, they also need to fully understand how IP relates to corporate strategy and have processes in place to assure that critical issues related to IP are brought to the board’s attention in a timely manner. This is a matter of both (1) knowing enough to ask meaningful questions and (2) having in place processes that bring information to the board’s attention.

A corporate board needs to ensure that it has both the knowledge and resources necessary to provide management with meaningful guidance on IP. A nonexhaustive list of topics to consider includes:

  • What are the key impacts of IP on the company’s strategy, the risks associated with that strategy, and the bottom line?
  • Are the company’s revenue assumptions dependent on IP protection? If so, how much?
  • What proportion of corporate assets is represented by the company’s IP assets, and is the company achieving optimal value from these assets?
  • Has the company explored all opportunities to extract value from its IP? Has it missed opportunities to do so?
  • Is the company investing adequately in the development of new IP assets?
  • Can revenue be generated by selling or out-licensing IP assets that are no longer associated with the company’s strategic focus?
  • What will the competitive landscape look like in the future, i.e., 2 years, 5 years, 10 years, and 20 years down the road? What significant IP issues is the company likely to face in those time frames, and are they being planned for adequately?
  • Has the company utilized investment vehicles that include or claim IP rights?
  • Are practices/policies in place to timely deal with assertions of infringement?
  • Are appropriate practices/policies in place to assure that the company protects itself against claims of willful infringement?

Corporate directors must understand, focus on, and question issues and policies pertaining to all corporate IP, including patents, trademarks, copyrights, and trade secrets. A discussion of each of the different types of IP and issues attendant to each one is beyond the scope of this article, but the gist of it all can be boiled down to the following: (1) Is the company adequately protecting its intellectual assets? (2) Does the company have the appropriate practices and policies in place? (3) Is the company being fiscally responsible with obtaining IP and maintaining it (or getting rid of it)? and (4) Does the company understand the marketplace in which it operates and how its competitors are acting?

In addition to being knowledgeable about the company’s IP assets, the board also needs to ascertain that processes are in place that will provide it with the information it needs to understand and address IP issues — and especially risk associated with IP — in a timely manner. The board should have access to appropriate expertise and resources to help determine what information it requires and to help it process the information. This is especially appropriate for life sciences and technology companies where the technology and issues are especially advanced and intricate. Practices and procedures that should be implemented in this regard include:

  1. having regularly scheduled board agenda meetings to discuss the company’s IP portfolio and all issues pertaining thereto. This might entail designating an IP committee that meets and reports to the board on a regular basis.
  2. ensuring the development and documentation of internal IP controls to identify, measure, manage, control, and ensure legal compliance in connection with all IP assets.
  3. ensuring that the board is fully informed on IP issues through activities such as:
    • regular audits of the company’s IP assets, protections, and environment
    • an analysis of the company’s IP positions as they pertain to/compare to its previously identified key competitors (now and foreseeable)
    • an analysis of emerging trends that could impact the company’s IP assets and related strategy in both short and long term
    • ensuring that the Board is provided with regular reports on IP issues as well as discussion of benchmarks with competitors’ practices.
  4.  ensuring that corporate officers fully comply with the requirements under the Sarbanes-Oxley Act, the corporate laws of the company’s state of incorporation, the laws and regulations of the various intellectual property offices in the United States and around the world, as well as all other legal requirements.

Misjudging the value of corporate intellectual assets and/or failing to properly oversee a company’s IP assets (or those that manage them) can prove to be dangerous; it may even be fatal to a company’s future. It’s not unforeseeable for a corporate shareholder to claim that a company missed opportunities to extract value from IP. These claims could escalate into shareholder dissention that results in costly litigation. It is, therefore, essential that companies have mechanisms in place to satisfy the duty of care and to evaluate and deal with IP issues on an ongoing and diligent basis.

About The Author
Barry Marenberg, Esq. has practiced patent law for 16 years. He was previously an in-house patent counsel to Bristol Myers-Squibb and was also the chief patent counsel at Enzon Pharmaceuticals. Presently he is the chief IP strategist at BJM BioPat Solutions, a consulting practice.