Underwriting the risks of Innovation

The expense and labor invested in the development and subsequent protection of valuable intellectual property (IP) can be and usually is, significant. Given the high cost of protecting IP assets, what can be done when outside factors, such as a party’s ability to pay or geographical location, create unfair advantages over competitors? As many smaller innovators will attest, there is a real fear of losing ownership of IP when they lack the resources to protect their rights. The insurance industry may offer a solution that eliminates unfair advantages created by financial resources, geography or the sophistication of an innovator. Todd M. Rowe, Attorney, Tressler LLP in the United States, looks at how, in addition to providing additional resources for establishing rights to IP, insurance can offer the means for innovators to focus on developing their IP assets rather than the distraction of finding the resources to protect them.

A long time coming

The modern insurance industry traces its origins back to 2000 B.C., in Babylonia, when shipping merchants entered into agreements with traders to use their ships as collateral for loans to fund voyages. The fundamental elements of these agreements continued to govern trade in ancient Greece and Rome and throughout the Middle Ages. Merchants and traders quickly realized they could gain a competitive edge by spreading risk among a number of individuals rather than assuming it entirely on their own. During the 16th and 17th centuries, merchants began securing insurance for their vessels from a syndicate of other merchants which gathered at Lloyd’s Coffee House in London. In the Industrial Age, industrialists recognized a similar competitive advantage in spreading the risk of damage to their factories among themselves.

Innovators are realizing that using insurance to spread the costs and risks
associated with litigation increases their competitive edge.
(Photo: iStockphoto - Pekka Nikonen)

In the Information Age, the risk of high litigation costs related to protecting IP assets is increasingly the prime challenge facing the vast majority of smaller and mid-sized innovators. Surveys conducted by the World Intellectual Property Organization (WIPO) estimate that the average cost of patent litigation in U.S. courts is in the region of US$4 million, while litigation in other nations can easily reach tens of thousands of dollars.1 Like the merchants and industrialists before them, a number of innovators in the Information Age have started to see that spreading these costs and risks through insurance increases their competitive advantage.

Insurance policies for IP assets

In general, insurance for IP assets can be offensive, insofar as it provides protection when a third party infringes the policyholder’s IP, or defensive, by offering protection in the case of infringement claims against the policyholder. The insurance policies available for IP assets spread the risks associated with innovation in three main ways: by

• paying solely for the policyholder’s defense costs;
• reimbursing business costs and losses incurred by a policyholder during litigation; and
• providing coverage to pursue infringers of the policyholder’s IP assets.

Defense cost & damages reimbursement coverage

The insurance industry has developed products that provide coverage if a policyholder is sued for infringement. These products reimburse defense costs incurred by a policyholder in infringement litigation and are commonly known as “defense cost and damages reimbursement” insurance. In addition, they enable policyholders to assert claims of invalidity against a complainant, fund research to re-examine the validity of the policyholder’s IP rights and may pay for any damages awarded against a policyholder. Coverage is provided on a “claims-made” basis, which requires that a lawsuit be filed during the period in which the policy is effective. Typically, coverage is contingent upon the policyholder obtaining an opinion of non-infringement from the United States Patent and Trademark Office or similar government body. Coverage under these policies is typically excluded for willful acts of infringement. Importantly, these policies are defensive in nature and provide no coverage to policyholders in enforcing their IP rights against an infringing party.

Multi-peril coverage

Other insurance products provide coverage for certain additional costs incurred as a result of infringement claims against a policyholder. Known as “multi-peril” policies, these insure against losses sustained from liability for infringement of another‘s IP. A typical example would be a homeowner’s insurance policy which provides coverage against “perils” such as fire, theft and other routine household risks. In the case of IP, multi-peril policies cover “perils” commonly seen in IP litigation, for example, business interruption, loss of commercial advantage, loss of trade secret advantage, as well as the cost of redesign, remediation and reparations that may result from protracted litigation.

Offense-based coverage

Policyholders can also obtain coverage for reimbursement of costs associated with enforcing IP rights. Known as “abatement policies,” these extend coverage to policyholders for enforcing their IP rights against potential infringers. These policies also provide reimbursement for the use of expert witnesses as well as other costs incurred in proving infringement. Coverage is provided on a “claims-made” basis, which requires that the infringing conduct take place during the policy period. To establish coverage, policyholders must typically obtain a legal opinion stating that they hold the rights to the IP. Abatement policies bar coverage for any willful acts by the policyholder that may have given rise to the infringing conduct.

The abatement policy has another feature unique to the insurance industry in that monetary damages awarded for infringement are allocated between the policyholder and the insurance company. The insurance company, however, will not receive amounts exceeding 125 percent of the costs paid toward litigation. While an abatement policy allows a smaller company to enforce its rights against a larger one with more resources, this type of coverage has been criticized in that insurance companies might only pursue litigation for those cases considered to promise a successful outcome. Moreover, any monetary award made against the infringer does not go back into the policyholder’s pocket. Instead, amounts recovered through judgment or settlement are used to replenish the funds available to the policyholder in the event that any future claims are made under the policy.

Leveling the playing field

IP insurance can help “level the playing field” for smaller to mid-sized entities. (Photo: iStockphoto malerapaso)

Unfortunately, the significant litigation costs and effort required to protect IP rights can create an unfair advantage for title holders with larger resources. A number of factors can create an imbalance between the “haves” and the “have-nots.” First, the size of an innovator, or its level of sophistication, can play an overriding role in determining property rights. That is, a smaller entity is inherently at a disadvantage against a larger one. Insurance coverage treats policyholders equally, regardless of size or sophistication. Charles T. Baxter, Vice President for Market Development of Intellectual Property Insurance Services Corporation (IPISC), an IP risk management firm based in the United States, observes a growing interest in IP insurance on the part of smaller to mid-sized entities, as a way to “level the playing field” with larger corporations.

Mr. Baxter explains that “simply holding an IP insurance policy often enables companies to stand up to larger competitors that might otherwise have exploited their financial advantage in litigation. Attorneys tell us that IP insurance changes the dynamics of such conflicts. Because the policyholder now has the resources to reach a decision on the merits of a case, larger competitors are often more likely to reach a favorable settlement early in the case.” Consequently, insurance coverage may result in a fairer determination of ownership rights.

Geography may be another factor that separates the “haves” from the “have-nots.” As it stands, an entity based near courts or other readily available resources may have an advantage over one in a more isolated location. Insurance may offer solutions by placing a policyholder with few resources in a developing nation on an equal footing with a larger one in a developed nation. Mr. Baxter indicates that IPISC has policyholders throughout the world: “European companies continue to be interested in IP insurance, and IPISC is seeing significant applications from Pacific Rim entities. Smart companies in this global economy are concerned about enforcing their IP rights, or preserving their ability to sell products wherever they may do business.” Insurance, then, can eliminate disadvantages created by geography.

These, and other such factors, can be taken into consideration by insurers when determining whether to provide coverage and at what cost. From the standpoint of the insurer, the costs associated with insuring a sophisticated, highly-technical patented device for which there are competitors around the world presents higher risks than would an average homeowner’s insurance policy. This increased level of risk translates into a higher policy premium. In an effort to gauge risk, the specialized application process for IP insurance requires general information from an applicant, such as any previous involvement in lawsuits and the applicant’s closest competitors and principal customers. For example, to cover a patent under an abatement policy, the applicant may be required to provide detailed information such as whether it had designed around any third party patents or received any notices that its conduct may be infringing. Close attention to detail and thorough disclosure of information is required during the application process, because, as with any type of insurance coverage, misstatements can lead to coverage being rescinded.

Conclusion

Insurance provides a distinct advantage in managing risk. While the nature of the risks has changed, the competitive advantage created by using insurance to manage them has not. The costs of enforcing IP rights or defending against infringement claims can be steep. After all, it must be assumed that a competitor will use all available resources in litigating IP rights. In an arena in which not all innovators are equal, insuring IP assets can offset some of these costs and can help level the playing field by allowing litigants to present their case under the best possible conditions.

____________________________
1  A Cost-Effective Alternative, WIPO Magazine, February 2010