Board accountability for patents

There has been much discussion about the value and import of patents in general, particularly through patent reform in the United States and similar considerations around the world. Such discussions tend to include finger pointing at non-practising entities (NPEs), dubious unscientific estimates of the ‘$28 billion patent troll problem’, criticism of patent offices that grant low-quality patents and attempts to reform the legal system that allows those patents to be enforced. However, good, strong patents that result from real R&D and inventive steps towards a commercial purpose are very much alive and are critical to sustaining the US economy and levels of innovation. In 2012 the US Commerce Department published a report entitled “Intellectual Property and the US Economy: Industries in Focus”, which used thorough econometric analysis to demonstrate that IP-intensive industries support at least 40 million jobs and contribute more than $5 trillion to, or 34.8% of, US gross domestic product. A significant body of academic research – including a recent study commissioned by the US government and prepared by US national academies – has confirmed that a strong patent system is vital to the innovation economy. In addition, the patent troll problem is finally showing signs of abating, which means that the focus can return to protecting and disseminating true innovation.

Often, investment relies on innovation and the patents that protect it – a subject about which shareholders are becoming increasingly knowledgeable. This shareholder awakening should in turn be eye opening for corporate patent holders. With increased shareholder activism and sophistication about patent value and patent risks, corporations should ensure that they uphold higher accountability for:

• patent risk-taking decisions;
• public information disclosures relating to IP information; and
• the importance of patent information to M&A and other material corporate events.

This article discusses that accountability, primarily at the board level, in the context of each of these three scenarios, from a business, legal and policy perspective.

Duty to monitor patent risk taking

It is not news that a more robust patent market means both additional patent liquidity and risk to operating companies. Thirty years ago, an operating company could take view of its corporate footprint – the products and services that it offers – and rely on two things. First, despite patent infringement being a strict liability offence, courts believed patent searches to be too difficult to complete exhaustively, leading to a requirement of actual notice for a finding of wilful infringement. Second, patents held by certain entities – whether industry allies or non-assertive competitors – would not pose a risk to the company. Today, neither of these is a given. Patent searches have become reasonably manageable and patents do not always stay in the hands of their developer – they have become articles of trade, frequently transferred to entities with a higher propensity to assert them.

This is what markets for resources do: allocate assets to the owner to which the assets have the highest value or utility at any given time. Thirty years ago, there was no robust patent market; in fact, there were few, if any specialists or intermediaries other than law firms. Today, there is a much more robust market, with market makers acting as the first speculators in the evolution of intellectual property as an asset class. However, the rise in IP transaction activity is only one of many indicators of a changed ecosystem. In an article published earlier this year in the Santa Clara High Technology Law Journal (31 Santa Clara High Tech LJ 217 (2015)) on the issue of board oversight related to patent risk decisions, Ian D McClure detailed the following characteristics of the current patent market:

• Supporting the proximate accuracy of the often-cited statistic that the portion of today’s corporate value made up of intangible assets has inversed from 20% to 80% (Ocean Tomo) since 1975, patent filings in the United States have similarly quadrupled in that same period.
• A steady rise in patent litigation since 1990 was capped by an unprecedented 30% increase in US patent litigation filings in 2012 to reach 5,000 patent suits filed in a year for the first time in history. US patent litigation rose again in 2013 by 12%, demonstrating that the rise in 2012 was not just because of the America Invents Act. Although they dipped for part of 2014, the first six months of 2015 saw more US district court filings (3,122) than the first six months of any year ever.
• Average fixed costs of litigation remain high, at between $2.5 million and $5 million depending on the value at risk (AIPLA). An estimated $3 billion (BTI Consulting) was spent on legal fees in patent litigation in 2014. Overall median damages awards over the past 20 years have been approximately $5.4 million (PwC) (a bimodal distribution appears for operating company versus NPE suits).
• Despite In Re Seagate’s heightened standard for wilful infringement in the United States, wilful infringement findings have not waned significantly. Only 10% fewer findings occurred in the few years after Seagate than the same number of years before it (see Chris Seaman, 97 Iowa L Rev 417, 464–70 (2012)).
• In the United States, 96% of all companies make less than $10 million in annual revenues (US Bureau of Economic Analysis). Given that it can take up to $5 million in fixed costs to defend a patent litigation, with a risk of losing a further average of $5 million in damages, any company’s decision to expand its corporate footprint in a manner that could infringe patents risks the entire company, for all but 4% of US companies.
• Patent searches have become increasingly manageable, with new and increasingly accurate software tools and specialists to complete patent landscape reviews. Despite this, companies continue to adhere to a low standard for actual notice associated with the wilful infringement doctrine and either ignore patent searches or do not meaningfully consider search results for fear of being at risk for treble damages. The connection between R&D activity and prudent patent searching in advance of R&D investment is woefully inadequate.
• Patents have always been probabilistic rights with uncertainties regarding their validity and interpretation, but are even more so today, with an increasingly unpredictable jurisprudence and legislative environment around certain types of patent. Nevertheless, most decisions to increase a corporate footprint relative to known patents that pose risk is based on the absolute cost of designing around the patent relative to the potential cost of licensing or litigation in the future. Losers in this decision are always diversified shareholders and society (as explained below), and sometimes also non-diversified shareholders.
• Patent litigation events do affect shareholder value. For example, when a federal jury in Pittsburgh ordered Marvell to pay a $1.17 billion award (since reduced) for infringing Carnegie Mellon patents covering integrated circuits in 2013, Marvell’s stock price fell to its lowest point of $6.98 per share, resulting in an approximate market capitalisation of around $3.4 billion – half of what it is today. Although stock prices can go up if a company wins, studies have shown that the wealth effect is generally net negative. For example, the announcement that Samsung lost its patent litigation against Apple and was ordered to pay $2 billion in damages (since also reduced) resulted in its stock price falling by 5%, while Apple’s stock price increased by only 2%.

Patent infringement risk arises when a company does not proactively identify problematic patents relative to its corporate footprint, or identifies problematic patents but decides not to consider the risk properly for fear of creating a paper trail, decides that the risk is not real because the patent owner is not a threat or decides that the reward is worth the risk. Dealing with the risk is seldom proactive. I know this because our firm, Black Stone IP, LLC, is routinely engaged to advise operating companies about their position and risk within a patent landscape, or to gain leverage in defending a licence offer or litigation through acquisition of strategically targeted high-value patents to counteract the risk. Most of these engagements are a reaction to patent risk taking that has already occurred, cannot be reversed and was possibly green-lighted without informed C-level input or oversight, or without proper engagement of in-house IP professionals.

The commercial practice of some companies relating to patent knowledge, in anticipation of their use and import in future patent litigation, is counterintuitive to the mission of all patent systems to disseminate patent information. Intentional ignorance of – or excessive risk taking relative to – problematic patents should be subject to stricter scrutiny and oversight. Although patent infringement is already a strict liability offence, raising the responsibility for patent risk decisions may be in the best interests of corporations and could help them to avoid deadweight costs of litigation and to accelerate innovation. Because patent litigation has a net negative impact on shareholder value, a higher level of accountability for patent risk aimed at reducing patent infringement and, as a result, litigation benefits diversified shareholders. Given that most shareholders are diversified, this means that it also benefits society.

Consider that to patent holders, the $3 billion in legal expenses for patent litigation in 2014 is viewed as a necessary means of protecting their patent rights in the only forum available: court. To a diversified shareholder, it is an added deadweight loss to a net negative wealth position resulting from patent holders’ frequent reliance on the courts. To society, it is money that could be spent on designing new products and solutions. To large law firms (750-plus attorneys), which received more than 70% of the $3 billion spent on legal fees for patent litigation in 2014, this is obviously a short-term winning situation. No matter what the perspective, a small factor contributing to this deadweight loss is still being considered by US patent reform – abusive litigation. However, the main factor has not been addressed at all – pervasive infringement and excessive risk taking by operating companies, relative to patents owned by other operating companies (as opposed to relatively small risk from NPEs).

Accountability for the risk identified above should match the level of that risk. Since that risk will at least affect shareholder value and, for 96% of companies in the United States, could eliminate it altogether, there is a reasonable argument that the ultimate responsibility for monitoring this risk should go to those responsible for safeguarding shareholder value: the board of directors. The goal, of course, would not be to find a way to hold boards liable for ignoring this duty, but for all good corporate citizens to uphold this duty by ensuring adequate decision making and proper oversight to protect themselves, their shareholders and society.

An open door

Board fiduciary duties relating to intellectual property have been the subject of little academic comment to date. To the authors’ knowledge, no academic comment on board fiduciary duties relates to the management of patent infringement risk. Robert Sterne and Trevor Chaplick – the only other authors we know to have highlighted the issue – have likewise acknowledged that it is “a topic that has received surprisingly little attention”. Nevertheless, as the recognition of patent asset value increases, and as patent infringement filings rise in tandem with the fixed costs of patent litigation and the variable costs of losing, the duty to monitor excessive risk taking relative to patent infringement becomes ever more important. Not only has this duty decent legal precedent on which to stand, but there is also good reason to lobby for its greater acknowledgment and effectiveness. After all, the patent community has long been talking about getting the C-suite involved in IP decision making. If what the patent market knows collectively about the value and risks of intellectual property is not enough ammunition to get its attention, a legal duty and a shareholder awakening should be.

At least in the United States, as corporate fiduciaries, members of the board of directors have obligations to the corporation, which are guided by a duty of care and of loyalty. Under the duty of care, the board is obliged to exercise good business judgement and to use ordinary care and prudence in the operation of the business. Although there is no statutory codification of the duty of care in the Delaware General Corporation Law, Delaware courts have shaped the duty through a web of opinions. Because many significant US companies and other globally headquartered companies’ US subsidiaries are incorporated in Delaware, and most US states look to Delaware corporate law as guidance, this jurisdiction is critical. Further, the duties are included in Sections 8.30 and 8.31 of the Model Business Corporation Act, which was largely adopted by many states.

An account of the important case law in this area would include Graham v Allis-Chalmers Manufacturing Co, which in 1963 became the first US decision to recognise the board of directors’ responsibility to prevent corporate misconduct (“illegal acts or wrongdoing of the corporation”). In 1985 the court in Smith v Van Gorkom (also known as the TransUnion case) held that board decisions must be adequately informed, and that directors must invest time and resources into investigating the options and engaging competent advisers before selecting the option that is in the best interests of the shareholders. However, the most important legacy of this case was that it prompted the codification of Section 102(b)(7) of the Delaware General Corporation Law, which permits Delaware companies to adopt charter amendments that exculpate directors from personal liability for breach of the duty of care. Successfully proving breach of the duty of care already means overcoming the business judgement rule, which lends directors a presumption that they have exercised due care. With the addition of the Section 102(b)(7) exculpation clause, the risk from breaching the duty of care is all but non-existent. Importantly, Section 102(b)(7) exculpates only directors from the duty of care and the business judgement rule is invoked only when the board has made a decision. The extremely limited enforcement of the duty of care is a nod to the overarching preference that boards be risk tolerant instead of risk averse. However, what happens when ‘risk tolerant’, in the patent risk context, always means a net negative wealth effect to diversified shareholders? The resulting lopsided balance of interests may ignore the idea that accountability can have the healthy effect of deterring almost-egregious mistakes and incentivising thoughtful decision-making processes.

In 1996 the decision in In re Caremark International Inc Derivative Litigation became the most comprehensive exploration of the fiduciary duty of oversight of corporate actions. The decision confirmed the duty to assure that a corporate information and reporting system exists. For 10 years, the duty was thought to linger under the umbrella of the duty of care, safe through the device of the business judgement rule and the Section 102(b)(7) exculpation clause, until Stone v Ritter in 2006.

In this case, the Delaware Supreme Court held that Caremark was really about the directors’ duty to act in good faith, and that the duty to act in good faith is subsumed by the duty of loyalty – not the duty of care. As a result, a claim for breach of the duty to monitor corporate misconduct falls under the duty of loyalty, and the exculpation clause and the business judgement rule are no longer shields. This is a critical piece of information when considering the potential enforcement of this duty and is a key reason why boards should pay due attention to patent risk taking (ie, actions that could give rise to infringement in the face of so-called ‘red flags’, as described below).

The next step in the progression of demonstrating that a higher accountability for patent risk exists relies on the parallel between patent infringement and corporate misconduct. Caremark and Stone are clear: monitoring and oversight are key to the good-faith obligation of boards of directors as corporate fiduciaries. Also clear is the fact that not all activities of corporate employees can or should be monitored. Thus, in the oversight context, it is important to discern the board’s obligation with respect to the organisation and monitoring of the enterprise to ensure that the corporation functions within the law to achieve its purposes.

Patent infringement is conduct prohibited by federal statute in the United States – namely, 35 USC 271. Patent infringement is not criminal conduct and a claim for patent infringement is brought in a civil suit. It does not carry criminal penalties. Instead, it is a prohibited act in violation of the exclusive rights of a patentee, granting it the right to bring action for damages or injunction. Copyright infringement, on the other hand, may be a criminal act with imposable statutory fines. Despite this difference, no language in Caremark and its line of cases expressly restricts the duty to monitor criminal conduct. Moreover, all of the rhetoric, both in these cases and from scholars commenting since, has been ‘wrongdoing’ or ‘compliance with the law’. It does not seem that the goal of the duty is to monitor criminal conduct alone.

An important limitation on the duty is that red flags must exist. In the patent context, the following may be sufficient red flags to ensure that patent risk taking is subject to proper oversight:

• The corporation operates in a litigious patent space;
• The corporation does not own or license every patent (or at least key patents) that would be needed to cover its footprint;
• The corporation or its competitors have been the target of demand letters;
• The corporation’s competitors have purchased or sold patents that are identified as posing a risk; or
• The validity of the corporation’s patents covering its footprint have been challenged by a competitor.

None of these red flags requires significant, cost-prohibitive investigation. Most exist for many large operating companies, especially for original equipment manufacturers.

Good policy, shareholder value and public interest

It is not just legal precedent that shows us why boards should pay attention. Good corporate and public policy says a lot about this issue too. Two of the leading academic minds in corporate governance policy have written that “the most intelligible construction of [the rationale supporting the board’s duties regarding illegal conduct] includes harm to shareholders and harm to society”. Specifically, “[s]hareholders are also citizens, and insofar as laws advance the general social welfare, citizens care about that. A diversified shareholder with small stakes in any one corporation may well find that the public interest predominates over the corporate interest” (Hill and McDonnell, 2007).

In the patent context, infringement by competitors could be assumed to directly harm the financial profile of the corporation that owns the infringed patent, as any market share or other exclusive benefit that could be held by the patent owner is diluted or eliminated. However, the infringer assumes the risk of patent infringement which could negatively affect its financial profile. In a US litigation environment without loser pays, both sides incur deadweight loss if the decision ends up in a dispute. As demonstrated above, assuming diversified shareholders and a large sample size of litigation (of which we certainly have both), a culture of rampant infringement and patent litigation is a detriment to investments that exceeds any benefit to them. This does not even speak to the goal of the patent system, which is thwarted when patents are ignored, and the innovation spending that is diverted to legal fees (to the tune of $3 billion a year). These same points have been made in the lobbying effort to control abusive litigation by NPEs. However, this ignores, in part, decisions made much earlier in the whole process, which could more effectively turn off that tap. It follows that there is a public interest – in addition to a diversified shareholder interest – in a duty to monitor patent risk, including implementing and paying due attention to a corporate reporting system that adequately searches for, assesses and makes informed decisions regarding risk taking relative to problematic patents. This position is supported by case law precedent, sound policy and logic.

Answering that duty

To satisfy its duty to monitor patent risk, a board should first establish a monitoring system which identifies, appropriately assesses and reports information about patent risk to the level of accountability corresponding to that risk. It should then pay appropriate attention to relevant information, whether internal or external, to ensure that it can spot red flags demonstrating patent risk or excessive risk taking related to that risk. As was the case in Caremark and Stone, a finding of breach of the duty to monitor patent risk will be very difficult so long as a board ensures that a monitoring system is in place and is paid due attention. The trick is to make those decisions based on the probabilities at hand after sufficient information discovery. Patent rights are probabilistic in nature, and every measurement of the risk associated with the proximity of a company’s footprint to problematic patents involves estimating and weighing multiple probabilities, including the probability that:

• key problematic patents have been found;
• the company’s footprint infringes identified problematic patents, especially if held by operating companies which are sophisticated patent licensors;
• the problematic patents are valid;
• the owner of problematic patents can or would enforce them;
• a licence would be offered at a reasonable price relative to expected fixed plus variable litigation costs; and
• designing around the problematic patents would cost more than a licence or expected fixed plus variable litigation costs.

The equation is not scientific, but the resources and information now available to patentees allow each of these probabilities to be reasonably approximated – at least to the extent that an action can be determined, ex ante, to be excessive risk taking as opposed to reasonable risk taking.

It is important that where the value at risk could be material to the company, the board ensures that the probabilities are identified, quantified and presented to it for oversight of the corporation’s decision to act. If the above is not enough reason to take heed, consider that shareholders are beginning to take note, with dramatically increased shareholder activity around patent management and patent risk, including increased shareholder derivative suits filed against corporations following patent infringement findings (eg, recent shareholder suits following Marvell’s $1.2 billion loss to Carnegie Mellon and DuPont’s $1 billion loss to Monsanto).

Public company disclosure requirements and IP information

Many of the world’s largest patent holders are public companies with corporate disclosure requirements mandated by securities regulators. Such requirements include an obligation to disclose to shareholders and other potential investors the value of their assets, any known significant risks and liabilities, and other material non-public information, including an ongoing obligation to update previously disclosed information. It is manifest that patents and their use and enforcement affect shareholder value, as described above. It should be equally clear that material changes to patent holdings, their encumbrances, usability and enforceability, as well as known patent risks and licence requirements, constitute information that shareholders need. However, it is not manifest that companies are under any requirements to disclose such material information to current and future investors, or that companies perceive any ethical or other obligation to provide more information about these assets or risks than blanket and boilerplate statements in their disclosures. There are good policy reasons for this, of course. A public disclosure of certain information – for example, the execution of a large patent cross-licence or in-licence – could expose a company to the risk of being targeted by other patent holders. The other side of the coin is: at what shareholder expense? Shareholders are becoming activists around intellectual property at an increased rate and additional transparency can make those activities less adversarial.

Corporate disclosure requirements landscape

Since the early 2000s, additional disclosure requirements for US public companies have been codified in US federal legislation in response to financial, accounting and other ethical scandals that have caused harm to investors. For companies listed on the New York Stock Exchange (NYSE) or the Nasdaq Global Market, the following are some of the rules and regulations imposed on boards and their committees:

• the Sarbanes-Oxley Act of 2002, as amended;
• the Securities Exchange Act of 1934, as amended;
• rules of the US Securities and Exchange Commission (SEC);
• the corporate governance listing standards of the NYSE and Nasdaq; and
• the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

The Securities Exchange Act and the Sarbanes-Oxley Act primarily govern the ongoing disclosure of information to shareholders and potential investors related to the company’s assets and activities. The annual Form 10-K and quarterly Form 10-Q filed with the SEC require a public company to disclose, among other things, audited financial statements and evidence of controls and processes for information reporting. The financial statements must include information about total assets and long-term obligations. In addition, they must include “risk factors” or “information about the most significant risks that apply to the company or to its securities”. The Form 8-K must be filed to disclose certain material information within two weeks of an occurrence or having knowledge. The goal of these requirements is to provide transparency to investors and potential investors about the business operations, financial condition, management and business and legal risks of the corporation. The accountability is not limited to the corporation, but extends to the board and executives themselves. For example, Section 906 of the Sarbanes-Oxley Act requires the CEO and chief financial officer to provide a personal certification accompanying each periodic report, stating – among other things – that the report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act.

Whether a public company is required to disclose certain information in a Form 8-K filing often depends on the significance, or materiality, of the event or information. ‘Materiality’ has been defined by the US Supreme Court as “a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available” (Basic v Levinson). More recently, in Matrixx Initiatives, Inc v Siracusano, the Supreme Court clarified that there is no bright-line test requiring “statistical significance”, and that any non-disclosed information – statistically measurable or otherwise – that would “significantly alter…the ‘total mix’ of information made available” in the eyes of a reasonable investor could be material.

Scienter, or intentional action, is also required to prove securities fraud under the disclosure requirements. Courts have held that an inference of scienter is proper only if the person signing the certification had reason to know, or should have suspected due to the presence of glaring account irregularities or other red flags, that the disclosures contained material misstatements or omissions.

Patent information disclosures in practice

A study of a number of recent SEC filings by US public companies, in combination with an investigation of patent transaction and assignment data, reveals many interesting things in light of the disclosure requirements outlined above. The results of this research will be published in a law journal later this year, but the following are summary highlights:

• In the three years before Alice (2011-2014), there were over 300 patent sales transactions (many with multiple patents) involving public company buyers in the same patent class as the patents invalidated in Alice (CPC G06Q).
• After reviewing patent acquisition data to determine the companies acquiring the most patents in the same classes as those in each of the US cases of Alice, Myriad and Mayo (invalidating those patents on patent eligibility) during the three years before each case, two public companies were among the top five companies in all three of the categories.
• Some of the above-mentioned deals were announced, including the value of the deal. No companies acquiring those patents, and no companies otherwise having large holdings (500-plus patents) of patents in those Cooperative Patent Classification classes, have provided any updated information to shareholders about any change in the perceived value of those patents.
• Based on a review of a large sample set of public company SEC disclosures (10-K and 8-K), it is evident that, in general, the bare minimum is disclosed; although some companies do much more than others.
• Known licensing obligations are not reflected in any filings, such as the following hypothetical:
  • A patent has been determined essential to a standard by a recent court;
  • The company knowingly makes products compliant with that standard; and
  • The company knows that it does not have a licence to that patent.

The piece of information unknown to investors is the third one, or the licensing activity. They must assume that there is no obligation if one is not disclosed.

Despite a general lack of disclosure about patent information, it appears that companies are relying on reasoned (and from some perspectives reasonable) arguments that these disclosures would put them at too much risk and are not required either because they are not material or because the risks or changes in value are probabilistic at best. There is even an argument that a known licensing obligation under this hypothetical is not an absolute, as the patent could still be held invalid. Still, shareholders today have an equally reasoned argument that they are the ones at risk not having the information; that the information is material because – as demonstrated above – patent events do affect shareholder value and therefore would alter the total mix of information to support an investment decision (under Matrixx); and that, probable or not, material risks must be disclosed.

The reason why public corporations should recognise this is the same reason why it is important to recognise the potential for a fiduciary duty to monitor patent risk: shareholders are becoming more aware. Before the issue becomes increasingly adversarial and this matter is dealt with through shareholder derivative and securities fraud class action suits, corporations should follow a path of increased transparency. They can no longer rely on a shareholder pool that is not sophisticated on patent issues – the information is important to them and shareholders should be important to the corporation.

Directors as auctioneers – patents in M&A and other material corporate events

A director’s core duties of care and loyalty – and the derived duties of good faith, confidentiality and disclosure – are important, if not highlighted, in the context of an M&A or other material corporate event. One of the first cases relating to the director’s duty of care in an M&A setting, the TransUnion decision (Smith v Van Gorkom), laid out the requirement that directors inform themselves “prior to making a business decision, of all material information reasonably available to them”, after they have had “sufficient opportunity to acquire knowledge concerning the problem before acting”. However, different standards of judicial review are applied in M&A or other critical corporate events. The business judgement rule is the default standard, whereby directors are presumed to be making decisions on an informed basis, in good faith and in an honest belief that their actions are taken in the best interests of the shareholders and the company – sometimes also called the ‘bare rationality test’. The courts will not second-guess tactical business decisions taken by board directors.

By contrast, the enhanced (or intermediate) scrutiny standard is applied by courts in special situations, such as defensive measures in response to a threat (see Unocal Corp v Mesa Petrol Co), or for approval of a transaction involving a change of control (see Revlon, Inc v MacAndrews). The courts will examine the reasonableness of both the board’s decision-making process (including the information relied on) and the actions taken as a result. Under the enhanced scrutiny standard, the decisions must be reasonable, not just rational, as is the test under the business judgement rule.

Under Unocal, where directors consider defensive measures against a potential threat, the directors’ decision-making process and actions must meet both of the following:

• There were reasonable grounds to believe that a danger to corporate policy and effectiveness actually existed; and
• The actions taken by the board as defensive measures were reasonable in relation to the threat posed.

Under Revlon, where the board of directors is deciding on matters involving sale of control or change of control, its fiduciary duties shift from a long-term focus on behalf of shareholders and the company to obtaining the highest value reasonably available for shareholders in the short term. When triggered, the Revlon duty changes the board’s duty to become auctioneers to get the best price in the short term for shareholders. The duty is triggered only once the board of directors actually adopts or recognises that the company is in play (ie, offered for sale). The board must consider not only price, but also:

• the offer’s fairness, feasibility, likelihood of financing and risk of not closing;
• the bidder’s identity and prior background;
• and the effect of the bidder’s business plans’ effect on shareholder interests.

The actual sale process is still protected by the business judgement rule, as long as there is no self-interest and the board is well informed. The duty involves a requirement that the board be fully informed on all material information, explore alternatives and evaluate financial valuation (usually by retaining reputable, conflict-free financial advisers). In other words, the board must be well informed of all material terms of the merger agreement and its impact on shareholders. The board also must actively seek and consider reasonable alternatives. Delaware law applies a materiality standard in disclosures that treats an omitted fact as “material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote”.

When a company owns a significant IP portfolio, the value of which rises to the materiality bar (as is the case in most technology companies), strategic alternatives regarding intellectual property must be considered with special care during M&A and other critical corporate events. The TransUnion external professional advice on strategic alternatives ought to be obtained from qualified IP specialists, not only traditional investment banks which may have no material experience in IP quality assessment, financial IP valuation, infringement analysis, evaluation of existing licensing arrangements and interplay of IP rights and current customer obligations. This last point is often critical: many a semiconductor company with a large patent estate may derive more value from some of its clients by licensing its intellectual property to them, assertively if necessary, rather than continuing to ship products at prices that do not account for its IP rights, as it has traditionally done.

If the company is up for sale, it is the board’s duty to inform itself adequately. The court in Revlon minced no words when it said that the role of the board of directors transforms from “defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company”, meaning that the directors’ duty shifts from considering long-term value (ie, acquiescing to an otherwise infringing client) to the duty to “get the best short-term price for stockholders”. This is a dramatic change, within which the value of IP rights, degree of risk taking and assertiveness in monetisation must all be considered. Under Revlon, the directors now have “the burden of proving that they were adequately informed and acted reasonably”. This advice typically cannot be obtained from traditional investment bankers; nor should they be able to issue a fairness opinion on the IP portion of the transaction, as they do not have the prerequisite specialist expertise in financial valuation of the intellectual property or in considering strategic alternatives with respect to intellectual property.

Perhaps the best example of this is the MIPS Technologies IP transaction, where the semiconductor company’s lukewarm $125 million enterprise value was dramatically increased to $475 million in a matter of months by signing an IP licence with its biggest customer, Broadcom, for $25 million, selling approximately 400 patents for $350 million to a consortium of 11 other technology companies, and then selling the remaining semiconductor core business to Imagination for $100 million. Had MIPS’s directors considered only the long-term value to shareholders, rather than getting the best available short-term price, they probably would not have marketed the patents as aggressively as they did for fear of alienating those customers by making IP demands.

Similarly, with hostile takeover threats – as discussed in Unocal and its progeny – the intellectual property is rarely considered as a response. When the threat is from a financial institution, intellectual property can be used as a poison pill by diluting its value dramatically subject to certain threats or events, similar to a long line of Wachtel inventions variously blessed or disallowed by successive Delaware decisions. Separately, the target’s intellectual property – which traditionally would not be used against the competitor for a whole host of reasons relating to mutually assured destruction strategies – may now be deployed as a nuclear option, given that a takeover threat is valid and imminent and not deemed to be in the best interests of the shareholders as determined by the target’s board. These issues must be investigated closely by the target’s board of directors and such investigation is possible only through a specialist IP adviser, who understands both the IP landscape and the competitive business landscape, and can provide guidance on IP valuation, strategic alternatives and the associated risks.