Will Patents Pose a Problem to Your Company?

Bob’s New York based software company [1] offers customized software systems to financial services clients.  Bob’s company was profitable during the high-tech bull market, but as the financial services industry fell upon hard times, he was unable to keep his business in the black. Bob decided that he would have to either sell his company to or partner with a larger company that would have the resources to keep the business (and its loyal employees) going through hard times. Bob’s first suitor was a competitor that recognized Bob’s position and smelled blood. Not only was Bob made a low-ball offer for the sale of his entire company, but during the course of the negotiations, the prospective acquirer sent Bob a letter alleging that Bob’s product infringed a patent held by the acquirer (and that Bob should cease and desist from selling his product or face litigation).  Bob understood this to be a bad-faith negotiation tactic to prove to Bob that his company was not worth the asking price.  Bob, a man of principal, immediately cut off further negotiations.

Bob’s second suitor was a prospective investor, willing to fund the company’s operations during the hard financial times. In conducting its due diligence investigation of Bob’s company, however, the cease and desist letter was disclosed and the prospective investor was unwilling to proceed with negotiations, being naturally averse to buying into the risk that Bob’s company could be forced to stop selling its main product. Unwilling to continue negotiations, the prospective investor insisted that if Bob wanted a deal, he would have to obtain a legal opinion that his company’s product did not infringe on the patent cited in the cease and desist letter. Recognizing the cease and desist letter as an obstacle to reaching his goals, Bob decided that he would have to obtain a non-infringement opinion.

For companies seeking investors or purchasers of its business (the purchase of an entire company being also an investment, this article will refer to both investors and purchasers as investors), the freedom to operate unimpeded by the intellectual property rights of others is as critical as a sound business model.  Though intellectual property generally refers to patents, trademarks, copyrights and trade secrets, patent infringement is usually the greatest concern of investors, because of its significant potential to end a company’s business.  

Patent holders have up to a 20-year monopoly in the right to exclude others from making, using, or selling the invention or method covered by their patents.  Patent infringement, accordingly, is the violation of any of a patent owner’s exclusive rights and may result in significant liability and consequences for the infringer.  Upon a finding of patent infringement, courts may prohibit the further manufacture and sale of a product, and may award damages consisting of royalties or lost profits.  Upon finding willful infringement, a court may award treble (3x) damages and attorneys’ fees. 

Most businesses are of course eager to bring new products to market, but small to medium sized businesses in today’s economic climate may not have the ability to dedicate the time or resources to figure out whether their products infringe any patents.  When the risk is considered, companies may forego clearance analysis for a belief in their ability to fly under the radar of any patent holders.  Some companies may also assume that if caught infringing, they will be able to negotiate licensing arrangements with the patent holders.  More deliberate or conservative entrepreneurs, however, may not throw all caution to the wind and will look to their lawyers in assessing whether their ongoing or proposed activities risk infringing valid patent rights. 

The small to medium sized company seeking investors may find itself being asked to obtain or provide an opinion of counsel that the company’s products do not infringe third party rights.  This will most often be the case if the business is operating in a crowded field or in a field dominated by major players.  Companies will be asked to undertake this significant expense because prospective investors will not want to “buy into” a lawsuit.  It is important to note that prospective investors may ask for an opinion even if the company’s products are themselves covered by issued patents.

The two most common types of opinion letters asked for by investors are clearance (also known as “freedom to use” opinions) and non-infringement (or invalidity) opinions.  Current patent practice discourages seeking traditional “clearance opinions” because of their expense and limited utility (i.e., it is unlikely that any opinion will provide ironclad guarantees that there are or will be no infringement problems, given the unknowns, like unpublished patent applications, that will necessarily qualify such opinions).  For example, an analysis of a product consisting of many components may require searching and assessing patents in a variety of fields, which could result in substantial expense.  Also, given the current trend towards filing patent applications on a variety of methods and virtually every patentable nuance associated with various technologies (especially in the consumer electronics field), comprehensive clearance searches are impractical if not impossible.  Sophisticated investors will understand this and, working with a company and its patent counsel, should be able to devise a way to get comfortable with respect to any “freedom to use” concerns it may have.  Such investors may find comfort in a patentability opinion covering a company’s own products, or in a patent search and assessment of a predefined area of concern.