Protecting Venture Investments Against Patent Litigation –

Over the last several years, there has been a significant rise in the amount of “bet-the-company” patent litigation. There are a variety of factors sparking this increase-a general increase in the number of patent applications and allowed patents chief among them-but the end result is that technology and emerging growth companies are bearing the brunt of its impact.

For many private, venture-backed companies the cost of defending a single patent at trial has become prohibitive, with some recent estimates placing the price tag at $2 million or more. Therefore, it is critical for today’s venture capital investor to both thoroughly diligence the patent risks in new investments and to proactively oversee the patent prosecution and litigation strategies employed by portfolio companies. Historically, such due diligence has fallen short by primarily focusing patent reviews on the breadth and strength of the claims in the patent and whether there were any obvious statutory bars to patentability. Given the very real risk of being sued for patent infringement, investors should take additional steps in their diligence to minimize risk and exposure.

Prior Art Searches

An investor can undertake a patent “prior art search,” which generally involves engaging a professional patent search firm to review existing United States patents and published patent applications relating to a specific technology. A good prior art search focuses on the product or service being offered by the company, not just the discrete technology behind the product or service. The search results will do three things: (1) provide insight into the competitive landscape and potential competitors; (2) reveal patents and published applications, if any, that could affect the company’s ability to continue conducting its business or require re-engineering of its products or services; and (3) identify competitive technologies, as well as areas of opportunity, for the prosecution of new patents.

No prior art search is perfect. A search, by its very nature, is limited in scope, as there are over 2 million existing patents and pending applications and not all of those patents and applications can be found or analyzed. Moreover, relevant patents will be issued and relevant patent applications will be published after the search is completed. Sometimes, relevant patents may be missing from the search files at the time of the search. Accordingly, it is advisable that at least one follow-up search be conducted six months to one year later. This will allow a company to adjust its strategy, if necessary, and to minimize risks going forward.

Investors may also want to consider obtaining opinions from counsel when they or their portfolio companies become aware of potentially problematic patents. If a company is found liable for “willful” patent infringement in a court action, it also may be liable for treble damages. One manner of avoiding a finding of willful infringement is to obtain a competent written opinion from counsel, often referred to as a “right-to-use” or a “freedom to operate” opinion, which can be relied upon at trial to demonstrate good faith and counter a demand for treble damages. If a company or an investor is aware of a patent that the company may be infringing (or is accused of infringing), it is prudent to engage counsel and obtain an opinion that advises the company whether it is free to operate in a given technology market. The opinion may indicate either that the patent is not infringed or that it is invalid. The opinion must be well reasoned and competent to be relied upon in court. Oral opinions are usually insufficient.

A good, well-reasoned opinion covering all of the bases will cost substantially more than a simple prior art search, generally from $20,000 to $40,000, and more for advanced technologies. The benefit of shielding a company from a finding of willful infringement, should it be sued, generally outweighs the cost of an opinion. A well-reasoned opinion also provides an investor with an additional tool in evaluating a return on its investment. Care should also be taken to ensure that attorney-client privilege is maintained, to the extent possible, on the opinion and any work that went into the opinion.

Patent Prosecution

One oft-forgotten aspect of a patent strategy and analysis is the practice of filing and obtaining a patent, otherwise known as patent prosecution. There are many advantages to a sound patent prosecution strategy, including the opportunity to protect a company’s position in a given technology market and to prevent a competitor from entering the market. A sound patent prosecution strategy should result in good patents that will increase the value of the company. One critical element to a successful patent prosecution strategy is the right culture and work habits. In software companies, for example, programmers with little exposure to patents often need to be trained on how to keep notebooks and records that will adequately support patent claims.

As a defensive litigation tool, a strong patent prosecution strategy is invaluable. The ability to leverage the fruits of a sound patent prosecution strategy in defending against a patent infringement suit improves the company’s position greatly. It can result in patents that provide for the ability to cross-license rather than paying damages, and it may also lead to a stronger bargaining position during settlement discussions and a better advocacy position before a judge or jury during trial. A strong patent portfolio may even prevent a company from being accused of patent infringement in the first place, because a competitor may see too much risk in suing a company holding a strong patent portfolio. A good patent prosecution strategy also requires monitoring competitors’ market activities to ensure that the prosecution strategy results in the best patents possible.

The results from a prior art search may be used to evaluate a competitor’s product strategy. By analyzing and directing its patent prosecution strategy to where holes exist in the competitor’s patent portfolio, a company can block its competitors from obtaining patents to cover those holes. The search results may also be used to focus research and development toward areas where competitors are heading to beat the competition, or to realize that alternative avenues need to be explored because the competitors are too aggressive or are too far ahead to make entry into the market worthwhile.

Secret Trading

A sound patent strategy also involves the consideration of trade secret protection. Generally, trade secrets do not provide as much protection as patents, but the former is popular in industries like software, where the shelf life of technology is short. Patent protection may not make sense because, by the time the patent issues, the technology is already obsolete. One alternative is to file a “provisional” patent application, which holds a place in the patent priority line at a relatively low cost-generally under $2,000. A full-blown patent application can then be filed within one year to one and one-half years after the provisional filing, and priority for the invention will date back to the provisional filing. During this time between filings, a technology can be evaluated to determine whether it is worth spending the money to obtain a patent or if trade secret protection is sufficient.

Another concern that emerging companies have with patents is that when they are publicly disclosed, larger competitors will simply engineer around them or even infringe upon them, and the emerging companies will not have the clout or market position to defend their patent portfolio. Utilizing provisional patents and the Patent Cooperation Treaty, however, companies can avoid public disclosures of their patent applications for up to 20 months. During this period, emerging companies can get established in their marketplace and be in a position to aggressively defend their patents when they are published.

Accordingly, a patent strategy that goes beyond the traditional due diligence of a company’s existing patent portfolio is advisable. Options to consider include conducting a prior art search to gauge the patent landscape, obtaining right-to-use opinions from counsel, and developing a comprehensive and sound patent prosecution strategy. Portfolio companies should also be encouraged to utilize provisional patent filings and the PCT, where possible, as well as monitor new patent issuances on a regular basis.

John J. Egan is a Boston-based partner at McDermott, Will & Emery, where he specializes in corporate securities, private equity and technology enterprises. He is one of the leaders of the firm’s Private Equity/Emerging Companies Group. Ray Lupo is a Washington-based partner in the firm’s Intellectual Property Department .