IP Protection – not for the faint hearted

In the cold, hard world of international technology, intellectual property can often emerge as the most prized part of a business and something others will try to wrest away. Alan Deans explains how directors and their companies can become sitting ducks if they don’t take action to protect this valuable asset.

Geoff Marshall expects that the company he heads, Nanosonics, will be selling its first device that can eradicate hard to kill bugs from specialist medical equipment before 30 June next year. By that stage, Nanosonics will be able to claim ownership of up to six trademarks and eight families of patents to protect its critical intellectual property (IP) from copycats and pilferers who could otherwise quickly reduce the business to a worthless shell. Welcome to the cold, hard world of international technology, a space in which a large number of Australian corporations now compete because brainpower, processes and services have overtaken traditional manufacturing as the heart of our economy.

That means directors and management are increasingly confronting the intricacies of IP protection as their intellectual know-how becomes more and more valuable. In many cases, IP is by far the most prized part of a business. Without high fences erected around these assets and the adoption of detailed risk management policies, companies are in grave danger. The unwary face legions of patent attorneys who are eager to use the courts and loopholes to seize ownership of other people’s toil rather than pay licensing and royalty deals. It’s no place for the faint-hearted.

Intellectual Asset Management magazine from the US has been warning for some time that directors are sitting ducks as shareholders line up to launch their first major IP-based lawsuit. “The day a set of directors and officers loses a suit based on the mismanagement of IP assets is the day the whole IP world changes,” the publication observes. “Because it will be the day that IP forever becomes a central concern for all senior executives in every publicly quoted company in the US and most likely beyond. When they see one of their contemporaries fired, fined heavily, paying out damages or even jailed because of an IP-related disaster, executives will realise that the IP for which they are ultimately responsible can have a direct consequence for them, and they will do whatever is necessary to avoid potential trouble.”

In Australia, one case has already come before the courts. That was when the Australian Securities and Investment Commission took a small Perth-based biotechnology company, Chemeq, to the Federal Court for breaching continuous disclosure laws (see break-out on p25). IP lawyer Rob McInnes, a principal of Spruson & Ferguson, warns that boards need to recognise that IP now frequently makes up the vast value of enterprises. “Directors need to understand that they should not endanger that. They need to enact a risk management strategy to ensure that they have the best possible legal protection for their intellectual assets.”

It’s a lesson that Marshall says he has taken to heart. While none of Nanosonics’ directors are IP specialists, the company has a board that is widely experienced in technology start-ups and development companies. Chairman Maurie Stang also serves as chairman of Aeris Technologies and as managing director of Novapharm Research. Director David Fisher held senior positions at Sweden’s Pharmacia and was general manager of Peptech. He is now a director of several technology investment funds. “We don’t suffer from not having a trademark or patent person on the board,” Marshall explains. “The board is informed [about IP matters]. But it’s really there to provide governance, strategic advice and risk management. It doesn’t provide advice to our IP manager.”

Despite being in the advanced commercialisation phase of its development, Nanosonics has adopted a sophisticated IP strategy that so far has kept it in good stead. “We took a conscious decision not to develop a technology that competed directly with a gorilla,” says Marshall. “That’s just not smart. Our judgment was to find an area that the big guys had not picked up. That way, they will leave you alone or they may even look at you and find you attractive. We simply don’t have boffins here asking what they can do. We have taken the path of having a strict, market driven focus. That’s another positive for our shareholders.”

The technology that has been developed by Nanosonics sprays ultra fine particles of hydrogen peroxide in a controlled environment – essentially a cleaning chamber like a small dishwasher – so that medical devices, including endoscopes and internal ultrasounds, can be properly sterilised and disinfected. Hydrogen peroxide has long been used for such purposes, but not in the manner developed by Nanosonics. Development is now at the stage where regulatory applications are about to be filed for certification in Europe and where the company’s focus is switching to effectively manufacturing and marketing its devices. While it had early seed funding from 3M, it has no immediate plans to seek licencing deals or other tie-ups with multinational medical device companies.

Its general manager of innovation and technology, Ron Weinberger, has developed a methodology to protect the IP which is broadening out to cover not just the devices but the system for measuring its efficacy and also a growing number of other uses. He works with a consultant to review potential patents. “We have to make sure that we are not stepping on anyone’s toes,” he explains. “If we find that we are, then we need to manage how to handle that. We have to constantly keep ourselves up to date.” Apart from using outside consultants, Weinberger also receives assistance from an advisory board that Nanosonics has appointed to represent a wide variety of disciplines rather than simply scientific ones. It has a high degree of patent experience.

“They sit as independent experts who tell it like it is,” Weinberger says. “They are not frightened. They do not need to tell us what we want to hear. Individual directors will go to the advisory board if they need to.”

McInnes says that companies cannot afford to make mistakes when it comes to exploiting the IP they have secured. “Deals that a company signs to licence its technology are for the long-term. They can be for 20 years. Every dollar that a company makes from that field and that territory covered by the licence is made from the one piece of paper that protects their IP. That is why it’s much more likely to be material to the board and to financial markets than a supply contract or even a joint venture.

“All of the value is referable to the IP rights that protect it. The technology can be as good as you like, but if you can take your first product to China and make it for one-tenth of the price, if it’s not protected, then it’s not your proprietary technology.”

McInnes believes that companies need to carefully map out a strategy to ensure that they don’t make expensive mistakes. One precaution is to benchmark deals using proprietary databases that track the fine details of global licencing and royalty deals. “Increasingly, I am asked to access such databases and analyse the results for clients. Five years ago that did not happen,” he says.

Another frequently used tactic is to employ IP specialists to be lead negotiators. “They are not the sort of deals that many Australian managers have a lengthy background in,” McInnes says. “There are lots of variations and complexities. There can be a tremendous amount of trade-off between issues and deals often have to work in many jurisdictions. Australian law might have to be applied, but so too might US law. It can take six to nine months to complete a deal involving 10 to 20 rounds and exchanges of documents. A deal might incur professional fees of up to $200,000, but that will be for a deal often having a value of $100 million.”

McInnes says companies need to enter a negotiation well prepared. “It’s best to chart the issues. I do a matrix in order to determine the best possible outcome and what the walk-away position is. Then, it helps me to visualise how I am doing in the negotiation. That helps to sort out how to trade-off issues. You may not ask for such a large up-front fee for the licence, for instance, but instead get the buyer to pay for patent costs. Or, I may pay the patent costs if they pay to enforce them. Most clients use a spreadsheet so that they can analyse what a particular set of financial terms mean.”

He also uses a rule of thumb that licensors should pay fees that equate to 25 per cent of their gross profits from sales of the technology. “Although that has no basis in principle, there has been some empirical work that shows that across a number of industries the typical relativity is 25 per cent,” says McInnes.

But while the imperative for publicly listed companies is to maximise their IP positions so that they don’t leave themselves open to IP theft or be undersold, there are those who believe there are risks in asking too high a price.

CSL is one of Australia’s most successful technology companies, boasting ownership of more than 100 patent families covering its pharmaceutical and blood products businesses. The manager of its IP portfolio, John Cox, notes: “There is generally $1 billion between a good idea and a good product. A good idea is worth a lot, but there’s clearly a lot that has to happen after you have a good idea.”

Unlike many small companies striving to commercialise their own IP, CSL often buys the rights to other people’s work and then spends years developing them further. Cox estimates that about half of its IP has been licenced from others, frequently involving deals with universities and academics.

“I suspect that it is true these days that people are doing better in handling their IP assets because they realise that it’s important. Academic groups, for instance, are anxious to seek help. Certainly, at CSL, we are happy to help them. They are seeking help in areas where they wish us to be interested in what they are working on. We have skill bases in many areas of science. We also have it in patent management.”

Cox believes that companies should be wary about asking too high a price when licencing their IP. Very high royalty rates, he says, are unacceptable. Care should also be taken when it comes to timing a licencing deal.

Increasingly companies are being advised to bulk-up their patent coverage so as to cover as many aspects of their technology as possible. While many start out simply covering the core intellectual development, as commercialisation nears, the trend now is also to protect peripheral rights that cover aspects such as software, measuring and control processes and a wide variety of alternate applications. In Nanosonics’ case, for instance, it expects that its measuring technology will eventually be as important, or even more important, than its core devices.

But Cox has a warning. “A patent term is only 20 years. The time that it takes to go from a breakthrough to a product can be quite long. It’s very difficult to do it within 15 years. Patents for the vaccine that treats human papilloma virus (CSL’s renowned Gardasil product) were filed in 1992, but the product itself was not registered until 2006.

“It’s critical not to waste or lose time at the front end. You can very easily find that there’s nothing much in it for you if you delay. It is in the interests of any small group to seek help as soon as possible. The quality of the filed patent is becoming more and more critical with changes taking place in patent offices leading to more stringent examination. If you don’t have a well filed patent, it’s difficult to get broad claims.”

Toughening up IP disclosure

The disclosure of significant events impacting on a company’s IP could soon be substantially toughened under new regulations proposed in a discussion paper released by the Corporations and Markets Advisory Committee (CAMAC). Comment has been called for about so-called ‘fraud on the market’ actions by investors as part of broader law reforms of shareholder claims against insolvent companies, a matter arising in the wake of the collapse of the gold mining company, Sons of Gwalia.

CAMAC has outlined reforms that would better protect shareholders who buy stocks on the basis of misleading information if existing laws are changed so that they rank beneath unsecured creditors when claims are assessed. One method raised in the discussion paper is to “establish a rebuttable presumption of reliance on misleading or deceptive information” rather than the tougher hurdle that currently applies of having to prove reliance.

The CAMAC discussion paper notes: “… reliance is taken to have been established upon proof that the misrepresentations or omissions would induce a reasonable, relying investor to misjudge the value of the shares. The fraud on the market concept is not confined to criminally fraudulent behaviour, but applies to a much wider range of situations in which investors might be misled.” It also notes that in the US such a law has spurred a number of class actions.

IP is one area that could be the focus of investors.

The Australian Securities and Investments Commission (ASIC) won a landmark case in relation to IP against Perth-based biopharmaceutical company Chemeq. It was fined $500,000 in July last year in the Federal Court for breaching continuous disclosure provisions of the Corporations Act for two offences, one of which was IP related. The court found that Chemeq failed to disclose information about the commercial impact of a patent granted in the US in October 2004. The shares nearly doubled in value when the disclosure was made, but the company did not say that the individual patent was not materially commercial in relation to its patent portfolio and that it had difficulty in enforcing its rights. About 26 million shares were traded during the two-day non-disclosure period. The IP offence accounted for $350,000 of the total fine.

At the time, ASIC noted that this was the highest penalty awarded against a listed company for breaches of continuous disclosure. The judge hearing the case said: “Compliance policies and procedures will not be effective unless there is, within the corporation, a degree of awareness and sensitivity to the need to consider regulatory obligations as a routine incident of corporate decision-making.”