A director’s guide to modernising IP governance frameworks

Many boards and organisations that promote best practices fail to consider the stewardship of IP-related assets and risks. In fact, there has been little in-depth discussion surrounding board accountability with respect to intellectual property – mainly due to the lack of public information. This raises questions regarding where best practices can be drawn from and the applicable legal requirements for directors.

In general, many boards do not see intellectual property as a top risk. Various reports and surveys look at director focus and responsibility, yet most remain silent on IP-specific topics. At best, Deloitte’s governance reports note that 80% of corporate value is found in intangible assets. However, these reports only go so far as to recommend that when addressing intangibles, boards look at integrated reporting to understand where organisational value is created. They make no mention of the management or oversight of such assets.

This corporate intangible value aligns with many recent IP-based business events. For instance, IP valuations and divestitures during the Nortel and Kodak bankruptcies amounted to $5 billion. Further, Twitter made pre-initial public offering payments of $36 million to acquire 900 patents – a move designed to block IBM from filing a patent suit – while Facebook paid Microsoft $550 million for 650 patent assets. Uber recently settled a trade secret suit against Google, agreeing to stop the inclusion of the technology in question and offering Google an equity stake worth more than $240 million. There is also Kyle Bass’s so-called ‘activist short strategy’ of depressing stock value through patent invalidations.

PWC’s 2017 annual litigation study estimated that despite the downward trend of litigation in the United States in recent years, over 5,000 patent infringement cases were filed in 2016, with the median award for damages at $8.9 million. These numbers make it clear that intellectual property should not be ignored by boards or directors in IP-centric industries.

This disconnect between market actions and the mention of intellectual property in internal governance policies is a dilemma. Intellectual property presents a real risk and can have a significant financial impact on businesses and shareholders. As such, boards should consider IP-based governance topics to ensure that their corporation is appropriately engaged on the topic.

Yet given the limited legal and business literature outlining board mandates that intersect with IP-management topics, it can be difficult for boards and directors to understand the top IP-related governance issues. Drawing on governance and director decisions from both case law and existing patent pools, this article provides an overview of the IP-specific issues that a typical board of directors should consider and outlines the best practices for IP-based transactions and the top stewardship requirements for directors.

Overlap between intellectual property and governance

Governance is the process and structures used to direct and manage an organisation. Depending on the jurisdiction, common law, regulations and statutes may outline board responsibilities regarding such topics as fiduciary duty, duty of care and business judgement. While IP-specific topics are rarely referenced in governance law, they align with the practical IP-related corporate activities that a board may ultimately be responsible for and, by extension, directors’ fiduciary obligations to the corporation.

Patent and IP-related corporate regulations generally align with a board’s responsibilities or a company’s governance structure under the statutory requirements regarding business management. These requirements may extend to any business transaction affected by IP topics, such as:

• the delegation of the authority to operate the business, which may extend to providing expert IP advice;
• limitations on the managing director’s authority, which may extend to patent pools or IP transaction approvals requiring shareholder approval or a dividend issuance as a structured royalty payment to shareholders;
• the disclosure of conflicts of interest, which may extend to IP-related transactions or information;
• the overseeing of directors to ensure that they act honestly, in good faith and in the corporation’s best interests, which relates to the duty of care of both directors and officers; and
• the liability of a director to perform reasonable diligence and act in good faith, which relates to reliance in good faith on reports from advisers whose profession lends credibility to their statements.

What directors need to know

The general governance of corporations and various IP matters (eg, asset rights and infringement) are governed by both commercial and IP law, while secondary topics are governed by bankruptcy and insolvency law, employment and labour law and contract law.

While commercial common law may vary by jurisdiction, the statutory fiduciary duty generally requires directors to act honestly and in good faith. Patent-rich corporations must consider the commercial complexity of financial modelling, as well as invalidity and enforcement risks and potential antitrust issues, among other topics. Established governance rules should ensure that qualified IP professionals are engaged as needed to be able to show that a reasonably informed decision was made when a director discharged their duties. One way to address this duty is to use independent IP-based advisers or subcommittees. However, if a board determines that IP issues – such as M&A in IP-heavy transactions, litigation enforcement or key licensing settlements – must be decided, they should engage competent advisers and professionals. Reasonable care should be exercised in selecting these advisers, particularly for patent-centric corporations. Patents intersect technology and law in the business field; thus, board advisers must be competent IP professionals – for instance:

• lawyers with patent expertise;
• engineers with skill in the invention field; or
• accountants with financial modelling or patent damage calculation expertise.

While directors cannot be experts in all aspects, to make decisions, they should not rely in good faith on reports or advice from individuals who do not have the required level of professionalism.

A fiduciary duty or duty of loyalty requires directors to act in good faith, honestly and in the corporation’s best interests. Applying the duty of loyalty requirements to the IP corporate environment, IP assets may be assigned and licensed and patent pools may acquire, divest or encumber patents during transactions. With various stakeholders involved – particularly in complex IP transactions, such as the Rockstar Consortium, which purchased the Nortel patent assets – directors must ensure that they maintain their fiduciary duty to the consortium over stakeholders that they may represent. In the context of board responsibility, the fiduciary requirement of corporate obligations affects the oversight of IP-based corporate transaction decisions, such as approving litigation enforcement that may be beneficial to the corporation but a determent to a stakeholder’s strategic partner.

The business judgement rule generally applies to decisions made in good faith in a company’s interests and shields directors from exercising their discretion in decision making; however, this may vary by jurisdiction. In 1992 the Canadian Supreme Court stated in Peoples Department Stores that business judgement must also be exercised in determining a decision.

Citing the so-called ‘Revlon line’ cases from Delaware, the Canadian courts moved to support the US approach to business judgement, based on the notion that directors must not be confined to a priority of rules, but rather the business judgement of what is in the corporation’s best interests. Notably, in citing the Revlon cases, the Canadian courts stopped short by neglecting to extend to the same extent the fiduciary duty for business judgement decisions, which applies in IP-related business scenarios.

Under Revlon, directors of US corporations now have the burden of proving that they acted reasonably and were adequately informed by experts. This implies that, for Canadian corporations, there may be a lower threshold than Revlon in defining reasonable actions and informed decisions, suggesting that there may be flexibility regarding the source of information on which an informed decision can be made. This may not be true in the United States (eg, general IP advisers versus patent licensing-specific advisers).

Directors who sit on both US and Canadian boards must be aware that the extent of a director’s obligation to not breach their fiduciary duty may vary between jurisdictions. As such, IP advisers assisting a corporation in Canada may not be able to advise on US licensing. Regardless, the business judgement rule requires directors to consider the interests of shareholders, employees, consumers and possibly government actors, while ultimately acting in the corporation’s best interests.

Reality check

There are a number of practical risks for directors and boards which fail to pay sufficient attention to intellectual property.

Infringement and licensing

Patent infringement can affect corporate business activities and thus shareholder value. In some jurisdictions, patent owners may claim relief from infringement via:

• injunctive relief;
• compensatory damages;
• the accounting of profits;
• reasonable compensation;
• punitive damages; or
• the delivery and destruction of goods.

Corporate losses for infringement may also occur in enforcement situations where patent owners are ordered to pay the legal costs of unfounded assertion. Despite historically large payments affecting shareholder value and directors being charged with stewardship and risk management, there is little support in literature to indicate that general infringement risks are systematically brought to or reviewed by the board or that there is active board oversight, perhaps with the exception of a few IP-centric corporations. While, in hindsight, engaging directors in discussion and oversight may have mitigated the risk and financial impact of a certain situation, this raises the question of what level of engagement is required practically. Even without systematic oversight, where there is a risk that IP liability will damage shareholder value, deference should be given to experts on legal matters in the context of freedom to operate. Further, information reporting on this risk should reach the delegated management team, if not the board.

Bankruptcy and licensing

As intellectual property is an asset class, bankruptcy and insolvency can affect corporate risk management. In triggering a patent owner’s bankruptcy or insolvency, the bankrupt licensor’s property (ie, its intellectual property) may become vested in the bankruptcy trustee. With regard to copyright, this raises the risk of the trustee taking the licensed copyright and subsequently trying to reassign it, as it may be free of limitations. For a board, this risk can be seen as follows: for corporations entering into contractual licence agreements, oversight may be necessary to ensure that diligence meets the required duty of care surrounding IP transactions in regard to licensed structures where the IP owner’s bankruptcy may be a risk. Without diligence, corporations engaging in a licence may be faced with the risk of the contractual enforceability of the licence being terminated by either the trustee or the licensors. Thus, for corporations relying on IP-heavy transactions as a licensee, board oversight duties may be relevant when in-licensing or out-licensing activities are affected by the bankruptcy and insolvency of the patent owner or acquirer.

Conflicts and delegation

Under their duties of loyalty and good faith, directors may have to disclose an interest or material interest regarding a potential or actual conflict arising from a contract or transaction. In practice, conflicts of interest of experts or retained advisers may also be of board concern, which raises the following important questions for boards:

• Do the corporate guidelines include checks for conflict of interest?
• Is there diligence in hiring expert advisers?
• Is there an ongoing risk assessment for when skilled advisers assist more than one corporation in the industry?

Conflicts regarding board decisions may also arise in relation to the benefits to one stakeholder over another. As such, boards which oversee IP-based organisations, particularly patent pools, may need to consider the demands or royalty determinations of various patent stakeholders due to conflicts of interest. In these cases, the board may need to implement flexibility in pool decision making to look after corporate interests first and not, for example, discount the weight of one large patent stakeholder over a smaller patent stakeholder if a conflict exists between the two. IP-related conflicts of interest may be complex to manage in practice. In patent pools, there will be instances where multiple patent owners may have conflicting business benefits regarding pool enforcement through litigation or even during an acquisition of patents from one of the stakeholders for use by the pool. In these situations, it will be incumbent on the governance structure to implement relevant policies to avoid conflicts of interest, such as a standard of business conduct policy or a formal conflict of interest policy for employees.

Where conflicts arise, directors should consider deferring or delegating powers to a separate sub-group or the remaining directors who have no conflict. This approach aligns with that of many IP-related pools, which delegate decisions to committees or senior management to avoid conflicts of interest and ensure that experts perform adequate diligence and provide strategic IP alternatives for consideration.

Transfer of ownership

Research-to-IP commercialisation may be a relevant topic when technology transfer is coming from a research institution or university as these often have their own set of IP policies. In reality, case law which is specific to university technology transfers often deals with board and governance-related IP policies that are linked to issues which are not primarily IP-centric, including:

• collective agreements and bargaining;
• employment law;
• contract law; and
• limitations of judicial reviews around ownership or licence disagreements.

Nevertheless, all of the above issues carry important considerations for IP-heavy corporations, such as ensuring a legally enforceable transfer of an asset right from a research institution to a pool or other corporate entity for commercial use.

As regards ownership risks for boards, corporate risk exists with regard to breaches of contract and voided transfer assignments between an original research institution and an inventor. This raises a general issue regarding the level of diligence required for post-acquisition contractual requirements that carry forward with an original asset transfer. Institutional IP policies have a wide range of royalty policies and uncertainty in ownership rights may also require unexpected royalty payments in the future, which is a risk that directors must manage. Institutional IP policies may be linked to inventor employment status and arbitration clauses in institutional or labour policies. As a result, diligence and assurances of IP rights must be reviewed, along with diligence to ensure that original inventor rights are respected as per labour or employment contracts.

M&A

M&A can be complex and may require special oversight by either the board or management team. To mitigate corporate risk, boards must ensure that their experts rely on surrounding IP-specific diligence. For example, the mechanics behind patent pool structures and contractual obligations that may arise during corporate M&A activities, such as via a poison pill clause. A poison pill or viral patent clause may be enacted during takeovers or patent-assignment transfers may be present, which may alter the relationship of the patent rights that the corporation enjoys – a topic that shareholders, managers and the board should be aware of. Pools may also have a governance rule that dissolves membership, thus affecting IP rights for engaged corporations. Other contractual obligations in licence agreements may also contain provisions that terminate licences if patent validity is challenged. For boards, this raises practical concerns where either M&A activities or patent validity challenges executed by management put the corporation into an infringement position – a governance risk with financial and strategic implications.

Taxation and finance

IP transactions and assignment structures can affect corporate taxation rates. Corporate patent strategies can be used to exploit and transfer IP income to low-tax jurisdictions. Although directors should consider the corporate benefits of reducing taxes using transfer pricing, this also carries IP-specific risks of which they may be unaware. Setting low transfer prices for tax purposes could affect future damages or even help defendants to fight injunctions and argue for invalidity, non-infringement and lower damages. There may be a risk that irreparable injury cannot be shown if the transfer cost of intellectual property is quantified at a low number. Board oversight of tax planning and implementation has significant financial risks and should be part of corporate stewardship. To ensure that delegated management or subcommittees have performed appropriate diligence and that their corporate tax position is sound, IP-rich corporations must also ensure that they have not inadvertently created additional IP liability and that their duty of care has been met.

Modernising governance requirements

Directors who have inadequate oversight of IP-based corporate transactions or fail to consider strategic IP options may not be meeting their fiduciary duty or duty of care or their requirements regarding business judgement and the avoidance of conflicts of interest. An analysis of IP-specific governance issues relating to these requirements translates into recommended best practices that may be embedded into corporate stewardship.

In practice, governance issues intersect with various IP-based transactions and corporate stewardship surrounding:

• litigation;
• enforcement approvals;
• acquisitions;
• divestitures;
• M&A;
• licensing;
• asset valuation;
• asset taxation and transfer pricing, royalty and revenue sharing;
• dividend issuances;
• patent prosecution;
• antitrust;
• infringement; and
• freedom to operate.

Although striking a balance for director involvement in these issues – either directly or via management – may be a functional challenge for directors based on the availability of time and expertise, the above topics constitute the top IP-related governance issues that boards should consider.

To meet director requirements and simultaneously address the top IP-related governance issues, best practices regarding IP stewardship are recommended on topics relating to:

• financial risk and opportunity;
• reputational impact;
• shareholder engagement;
• corporate disclosure; and
• operational or strategic corporate guidance.

Financial risk and opportunity

Boards must monitor risk exposure of litigation or infringement damages due to the violation of other IP rights and other patent-related financial risk. This includes the risk of reduced royalty income linked to NPE characterisation by the courts. IP financing options must be considered, including debt-financing opportunities and transfer-tax positions, the latter of which can affect future royalty damage. Financial impact may also occur via loss of IP ownership or licensed use and associated royalty revenue or freedom to operate. This could be a result of:

• bankruptcy by the licensee, licensor or assignee;
• contractual limitations;
• encumbrances;
• the divisibility of rights; or
• a risk of assignment challenges.

Reputational, shareholder and disclosure-based issues

Boards must ensure oversight of IP transactions. Conflict of interest monitoring applies to multiple stakeholders (eg, with regard to patent pools, M&A and multi-party IP transactions) and potential IP-transaction approval, if required for a director decision. Vigilance for activist shareholders lobbying to monetise assets to the determent of the board’s defined strategy should also be considered. Further, disclosure requirements may need reviewing to ensure that they encompass material risks in IP transactions and the disclosure of other material IP risks. As regards reputation, boards must consider risks associated with asserting patents or being named an NPE.

Strategy-based topics

Boards must consider the impact that foreign government policy shifts may have on corporate plans. In addition, where patent pooling is a function, corporate directives must consider antitrust risks. Strategic alternatives should be considered where high freedom-to-operate risks result in injunctions that require the discontinuance of key business offerings, including loss of patent rights, either through invalidity, assignment challenges or encumbered rights and other contractual limitations. M&A decisions should include strategic alternatives based on IP risk or reward. IP-value assessments should be included in board discussions on strategic alternatives, particularly where high-value patent ownership exists. Finally, boards should assess the effects of conflicts of interest which require risk assessments for both conflict with expert advisers and director conflict for IP-specific transactions and monitor post-director departures.

A focus on these governance topics during either direct or indirect oversight should protect directors from allegations of a breach of their duty of care and provide a defence of reasonable diligence, good faith and acting in the corporation’s best interests. In order to rely on the delegation of content or business judgement rule, directors must prove that they made informed, reasonable decisions which, for IP-critical transactions, will require assurances from management that competent, independent IP advisers were engaged.

Moving from issues to best practices

In viewing IP-governance issues through the lens of boards and individual directors, five general best IP governance practices can be identified:

• IP oversight;
• code of IP conduct;
• director IP education;
• independent IP advisers; and
• scheduled IP-risk assessments.

Combined, these encompass all relevant IP-governance topics required to successfully manage IP-based risks and opportunities, as opposed to boards serendipitously addressing IP-based requirements.

IP oversight

Boards should implement an IP-oversight framework to cover the key areas of finance, reputational impacts, shareholder engagement, corporate-disclosure requirements and other operational or strategic guidance. The specific topics generally focus on assessing key areas against:

• IP litigation;
• enforcement approvals;
• acquisitions;
• divestitures;
• M&A;
• licensing;
• asset valuation;
• asset taxation and transfer pricing, royalty and revenue sharing;
• dividend issuances;
• patent prosecution;
• antitrust;
• infringement; and
• freedom to operate.

In addition, corporations based on a government crown model must expand their considerations to address government stakeholders, sovereign immunity challenges, trade policy lobbying and antitrust criticism.

Code of IP conduct

It is recommended that boards enable reviews via a code of IP conduct, which will promote risk management at both the executive and director level. In practice, a code of conduct may delineate areas of financial risk or limit where the executive team has authority to execute and where director engagement is required. The code will also set the stage to ensure a company’s IP-risk profile is considered at the board and executive level. Stronger board oversight is recommended to increase executive efforts and IP-risk mitigation.

Director IP education

It is crucial to ensure that adequate, embedded IP knowledge and awareness exists at the board level. For effective governance, boards must be able to understand and act on IP risk. Thus, best practices should be operationalised by ensuring that intellectual property remains a topic of director education in the form of board materials or is included in a board’s conduct requirements (eg, its performance measures).

Independent IP advisers

Boards should engage IP-specific advisers proactively and actively on ongoing IP topics. Having a plan of action with known IP experts ready for engagement is necessary. Proactive engagement will help to mitigate risk in a key IP event. Ongoing engagement ensures that oversight occurs as a company’s corporate IP-risk profile changes. This includes conducting conflict of interest checks for advisers and actively using advisers when board decisions are deferred to committees.

Scheduled IP risk assessments

Boards should consider best practices on a consistent basis via IP risk-related board discussions. For example, they should conduct an annual formal review of the corporation’s IP-risk position, taking into account the IP requirements of its marketplace. For IP-rich corporations, this review may need to be quarterly.

Addressing board resistance

Given that intellectual property is not directly presented as a top risk in many governance reports, boards may be reluctant to refocus on it and to implement best practices in this regard. However, corporate risk, shareholder engagement concerns and financial impact deriving from a lack of IP oversight suggest a clear requirement for boards to consider IP-based governance a top priority. At the very least, a minimum level of IP oversight should be enacted for directors to meet their fiduciary duty and duty of care and to comply with the business judgement rule.

But what of the added effort to enact an IP governance framework and prepare additional materials, given director limits on time and focus? Lack of board involvement carries risk and standardised oversight may be too burdensome, but is this reason enough to qualify resistance and keep intellectual property bereft of board discussions? In addressing hesitation, there will be a question of an optimal trade-off to find a level of best practices implementation that all boards can follow. This answer will be different for each corporation, but should be discussed and agreed on in forming the code of IP conduct; setting the tone here can reduce the perceived burden while still bringing intellectual property under discussion. In fact, there is rationale for implementing best practices, although recording discussions should be kept to a minimum in order to avoid discoverable materials. If materials are discoverable or privilege is lost in future litigation, detailed materials may generate additional business and litigation risk. Seen from this perspective, the added effort may be a minimal burden to bear.