Commercial risk

15 September 2006

Common practices among tech start-ups - like using open source software code or collaborating with universities - may be riskier than you think. Our second report on intellectual property explains why

Picture yourself bringing in an external consultant to help do basic coding for a new software product. Aware of the risks involved in working with independent contractors, you draw up an agreement with your lawyer that spells out the rules - everything from what they get paid to the fact that the contract bestows no employment rights. You take care to include a clause that specifically assigns any work the consultant does to your company, so there's no question in the future about who owns your intellectual property (IP). In short, you think you've got all the formalities covered.

What you don't take into account is the fact that the consultant is an avid fan of open source software, the freely-available code that's put into the public domain for anyone to use. As a result - and completely unknown to you - some of that open code ends up in your product. Months after you've put the software on the market, your patent is challenged, and it emerges that you've been charging for a proprietary product that includes open domain code. Suddenly, instead of defending your own patent, you could find yourself in breach of open licensing agreements.

This scenario is one of many common pitfalls awaiting IT, biotech and other technology firms in the complex world of IP. Many activities that start-ups take for granted during the development of their products - from collaborating with universities to offering indemnities in contracts - carry practical risks that can come back to bite them further down the line. With the costs of defending intellectual property (IP) disputes stretching into six or seven figures, it's worth facing up to them early on.

An imperfect science

One of the biggest problems of dealing with IP is that, like much else in law, it's rarely black and white. The Intellectual Property Institute in London, which provides a range of publications and seminars in the field, hosted an event last year aimed specifically at small and mid-sized businesses, explaining the commercial realities of IP law. Currently available on DVD*, the conference drew experts from the UK and US who warned of some of the pitfalls start-ups face, beginning with the basics of interpreting patent meaning.

Patents consist of a description of the product or process, along with a list of 'claims' specifying the different areas where the patent effectively imposes a monopoly. These claims are designed to ensure that if anyone comes up with the same kind of product - even if they developed it completely independently and with no knowledge of your work - you can stop them. To do so, however, you have to prove that your claims are both valid and that they've been infringed.

According to Henry Carr QC, an expert in patent and computer litigation, this is a difficult balancing act for the patent agents who put these documents together. On the one hand, the agent has to draw up claims that are as wide-reaching as possible, so that you can cater for all potential infringements in the future: on the other hand, if they're too wide-ranging, they'll be ruled invalid.

It's not easy for the people who rule on patents either. Carr says that over the years, courts around the world have spent vast amounts of time debating how the language of patents should be interpreted. Should the words be applied very literally, or should courts try to interpret their meaning? He points out that the literal approach is problematic - think of the person who reads the word 'concentrate' on a pack of orange juice and starts thinking really hard - but the alternative creates uncertainty for everyone else about where the monopoly begins and ends.

As Carr points out, sometimes it doesn't even matter whether you've got a good legal case. With some IP disputes, there's so much money involved that one side will want to pursue litigation regardless.

Managing everyday risks

None of this implies that you shouldn't take out patents - it makes sense to protect your IP if you believe it has value (see 'Deep pockets'). And you should also keep the legal risks in proportion. Speaking at the same IP Institute conference, Kim Cauthorn, director of forensic accounting and litigation consulting at Kroll, said that even in the highly litigious US, figures show an average of just 19 suits per thousand patents. She also pointed out that US patents are found invalid or unenforceable 45 per cent of the time - which may make you feel better if someone tries to use their own patent to prevent you operating in your field.

But Cauthorn also argues that there are a lot of everyday risks associated with intellectual property. One of the big issues she sees is ownership of the actual IP, which can get clouded if you collaborate with other companies or research institutes, or form joint ventures. Another is not knowing what IP you actually possess - while patents are easy enough to track, trade secrets are not, and many organisations don't know precisely what secrets they have. This is a particular problem in academia, where the instinct to share often results in individuals giving IP away. Other common risks include companies offering indemnities to third parties as part of a licensing agreement, which can leave them open to patent infringement action through their partners.

Cauthorn recommends that organisations centralise control over IP and formalise their processes to get round some of these problems. She also points out that in many cases, IP is only as valuable as your enforcement effort - so there's not a lot of point spending time and effort getting IP that you can't or won't follow through on.

Finally, if you do end up needing to enforce your IP rights, be pragmatic. Companies that can't afford to enforce their own patents sometimes assign them to larger companies with deeper pockets in return for a residual interest, or license both the patent and the enforcement rights to a third party. They might also put one IP portfolio up as security for a bank to allow them to borrow the funds to protect other assets. And in some cases, particularly in the biotech and semiconductor world, Cauthorn suggests the best approach is often to cross-licence and share technologies.

* 'Intellectual Property - The Commercial Reality for SMEs', a 3-DVD set available for purchase from the IP Institute www.ip-institute.org.uk

By Keith Rodgers, Webster Buchanan Research