Intellectual Property and the Entrepreneurial Economy: IP Protection in the Global Environment

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Michael A. Jacobs
Morrison & Foerster LLP, San Francisco, California

I am pleased to be here in Heidelberg at the invitation of the Klaus Tschira Foundation and the Heidelberg International Club to discuss with you the question implicit in the title of my talk: what is the role of intellectual property protection in entrepeneurship, and what IP protection issues are presented to entrepreneurs in an era of globalization and international markets?

In preparing my presentation, I asked myself why you might be interested in this topic, and what assistance could I, an American intellectual property practitioner, possibly provide?

After all, Germany specifically, and Europe in general, has a sophisticated intellectual property system. In some ways, the European system is envied by American intellectual property experts. Europe has high quality patent offices, competent patent examiners, a system for prior art searching that appears to be superior to that of the US Patent Office, a dispute resolution system that is less costly than the US system; Europe does not suffer from the uncertainty of trial of a patent case by a jury, and it has an outstanding IP bar. In general, the patent system in Europe seems simpler and clearer than the U.S. system.

So why might you be interested in hearing from an American about intellectual property? I answered my question about your interest in two ways:

1. As Germany specifically, and Europe in general, moves to spur the growth of high-technology business and to inject higher levels of dynamism into the economy, the perspective of an American, and more particularly an American from the San Francisco Bay Area with its now legendary Silicon Valley, on the role of IP in facilitating that growth might be of interest. This is the "entrepreneurship" aspect of my presentation.
2. I speculated that you might be interested in some thoughts about how to navigate the US system and what as non-lawyers one needs to know about IP protection in the United States, on the assumption that the size and dynamism of the US market makes IP protection in the US a relevant question. This is the "Global Environment" aspect of my talk.

I should begin first by defining some terms. By intellectual property protection, I mean the system for protecting intangible property, such as inventions, writings, and corporate identity. This system relies primarily on the laws of patent, copyright, trade secrets, and trademarks. So by intellectual property protection on a global basis, I mean the system for obtaining and enforcing these rights not just in the domestic context but in other countries, and particularly in the United States.

By entrepreneurship, I mean primarily high-technology entrepreneurship, that is, the process of identifying a new business opportunity that turns on the development and dissemination of an advanced technology, committing oneself to the success of that technology, and obtaining risk capital to finance the development of the technology. To be clear, by this definition, entrepreneurship might involve starting a new company, but it may also take place within an existing corporate structure (the term "intrapreneurship" is sometimes used to describe entrepreneurship within an existing organization). High-technology entrepreneurship is risky, but it offers the opportunity for high returns. In many cases, it also offers the opportunity to change the world: to change how a disease is treated, to change how energy is created, to change how people buy goods and services.

Let me next state and justify the central assumption underlying my presentation. That assumption is that intellectual property protection on an international basis is important, that it is a necessary, though certainly not sufficient, condition to successful entrepreneurship in today’s economy, and that one ignores such protection at one’s peril. In this connection, I was quite struck by the following passage from an article in a recent issue of the Economist about the challenges facing Poland’s universities, and more particularly the science faculties of those universities:

"Even if a Polish research team does make a discovery, it is expensive to patent internationally and hard, usually, to bring to the market. In America, it costs a good $10,000 in legal fees to establish a patent, more to hold on to one. In poor Poland, western companies are quick to pounce. Some buy Polish innovations (in genetics, for instance) for a song, others are happy to wait until patents expire, then grab the technology."

The Economist, November 6, 1999, p. 33-34.

Now as I noted above, by intellectual property protection, I do not necessarily mean only patent protection. The role of patents in spurring innovation, after all, varies from industry to industry.

In the case of the software industry, for example, innovation for many years was rewarded primarily through the protections of copyright and trade secret law. The former protected primarily against outright piracy through duplication of software distributed to end-users, while the latter protected primarily against employees departing with the company’s intellectual "crown jewels" and rapidly setting up a competing shop. In recent years, patent protection for software related inventions has increased in importance, but often these patents are obtained more for their value in deterring others from launching a patent lawsuit through the threat of retaliation than out of a genuine desire to protect one’s innovations through patents.

On the other hand, in pharmaceuticals, biotechnology, and medical devices, patent protection is critical to creating adequate incentives to innovation. In these industries, research and development and regulatory approval costs are enormously high, while the cost of duplicating the work of others through reverse engineering or laboratory analysis is low. Without the monopoly rights granted by patent protection, innovation in these industries would surely wither away, or at the least depend almost entirely on support from government research grants.

The electronics hardware industry is somewhere in between. Hardware manufacturers broadly cross-licensed each other through the middle 1980s. In 1986, Texas Instruments launched a major campaign to extract more revenue from its patent portfolio. Rather than merely renew its cross-license agreements, it demanded a substantial increase in royalties, and sued to enforce its demands. The results were impressive for TI, and fundamentally changed the role of patent protection in the electronics hardware industry. Now, patent protection is an important tool in staking out a competitive position and creating barriers to entry.

So what is the role, then, of IP protection in entrepreneurship? Flipping the question around, if one wants to be entrepreneurial, what is the proper place of intellectual property?

In the classic Silicon Valley model of entrepreneurship, several bright individuals invent a technology, form a small company, obtain several rounds of venture financing, develop the technology, release a product to the market, and go public. (There are, of course, variations on this story, including scenarios in which the start-up is sold to another company.) By going public, we mean issuing stock to public investors in an initial public offering, or IPO. Going public is critical to the whole process, because it is what is known as a "liquidity event," that is, an opportunity for the early participants, including the innovators themselves, to realize substantial profits on their investments.

The IPO is accompanied by a disclosure document called a "prospectus." Under the securities laws, the company and the investment bankers that underwrite or manage the IPO owe a duty of disclosure to the public that is fulfilled through the delivery of this document. Because of the risks of securities litigation, close scrutiny of the company in a period of "due diligence" is undertaken and the prospectus is carefully prepared.

From the standpoint of investors evaluating a potential entrepreneurial start-up, an early question is what the prospectus will say that will attract or deter purchasers of stock in the initial public offering. If the company’s technology is attractive, and the company will be able to present significant barriers to entry by competitors, investment capital will be easier to raise. On the other hand, if the start-up appears to have too much "hair," meaning issues and problems that might have to be disclosed in the prospectus if not resolved, then investment is less likely. Intellectual property issues figure prominently in this calculus.

On the negative side, investors will be concerned, for example, about intellectual property risks that might have to be disclosed in the prospectus. The company might have been formed, for example, under circumstances that suggest the possibility of trade secret misappropriation. Perhaps a group of employees left their former company together, and are working on a technology that is similar to the technology of the former company. In this scenario, investors will be concerned that the former company might launch a trade secret suit, perhaps on the eve of the IPO, requiring that the prospectus be amended and making the stock in the company less attractive.

Similarly, investors will want to know if the company has properly selected its trademarks and, in the Internet economy, has reserved the proper domain names. In the software world, issues of who owns the copyrights in the code may arise, particularly if, under U.S. law, consultants are used without proper putting proper written agreements in place. Investors might also be concerned about the possibility that a competitor may have patents that the new company might infringe, raising the specter of an expensive lawsuit and possible large damage awards or injunctions against product sales.

On the affirmative side, investors will want to know what the company will be able to report in the prospectus about its strategy for intellectual property protection and, in particular, its own pending patent applications or issued patents. Patents give the owner the right to sue a competitor for infringing the patent, obtain damages in terms of money, and obtain an injunction to stop the infringement. These rights can be quite important in protecting one’s unique niche in the market place.

I was recently involved on behalf of a young educational software company whose business is built around some patents that are exclusively licensed from the University of California and Rutgers University. A Midwest competitor was marketing its software product as a lower cost substitute product. Our client filed a lawsuit and quickly obtained a settlement in which the competitor agreed not to build similar software functionality and not to claim in its marketing materials that it was such a substitute.

Investors place considerable emphasis on developing these kinds of obstacles to competitors or "barriers to entry" through intellectual property. Enduring competitive advantages are otherwise difficult to obtain in today’s economy. Imitation is cheap and easy. A strong patent position can at least make life for imitators more difficult and, at the most, preserve an exclusive competitive position, as is often the case with pharmaceuticals that are protected by patents.

In working with entrepreneurial companies, our advice is typically two-fold. First, as with corporate matters in general, it is important to do a good job of intellectual property housekeeping, to have the proper agreements in place with employees, to avoid perhaps inadvertent trade secret misappropriation, and to pay attention to key patents in the field. Second, the company should have its own affirmative intellectual property strategy so that it can take advantage of the barriers to entry that intellectual property rights offers.

A company thus should develop both a defensive and an offensive intellectual property strategy, a defensive strategy to avoid claims from third parties, and an offensive strategy to protect one’s competitive position. This is the kind of plan that I believe investors are looking for when evaluating a potential high-technology investment opportunity.

One component of that strategy, and I must confess an often quite vexing component, is the international dimension. The basic problem is this: although there are many treaties and conventions that have gradually harmonized intellectual property protection on a global basis, the IP system is fundamentally a national system. In the EU, this is changing somewhat, with some rights or parts of rights available on a European-wide basis.

To protect one’s trademarks in the United States, however, one must apply for trademark protection in the US. It is insufficient to register one’s trademarks merely in, say, Germany or the EU. Conversely, if one has cleared a trademark for use in Germany, for example, but there is a possibility that one will be doing business in the United States, it would be necessary to clear that trademark in the US.

Trademarks are relatively simple and inexpensive, but the same basic rule applies for patents, which are complicated and expensive. That is, for a German company to obtain patent protection in the US, it must apply for patents not just in Germany, but also in the US. Conversely, if the German company’s goods or services are going to be available in the US, the company faces the risk not just of a patent lawsuit from a holder of German patents, but also the risk of a patent lawsuit from the holder of a US patent.

And just as the systems for obtaining rights are national in scope, the systems for resolving disputes are also national in scope. That is, if one is going to sell goods and services in the United States, one not only needs to plan to register for rights say, in the United States, one also needs to be prepared for the possibility of litigation in the United States. This means that the costs and other distinctive aspects of the US dispute resolution system need to be taken into account in formulating an IP strategy.

With a particular focus on patents, let me now turn to some distinctive aspects of the US system that German entrepreneurs who have an interest in the US market should keep in mind.

First, US patent law has certain unusual aspects that one should be aware of when preparing patent applications. If one hasn’t been through the process of applying for a patent before, it usually would work like this. A patent lawyer is notified that the company thinks it has a patentable invention. He meets with the inventors, takes a disclosure of the invention and prepares an application. The invention describes the prior art, that is, the technology that came before, and then provides a detailed description of the technical aspects of the invention. The application concludes with a series of claims in which the patent lawyer and inventor try to describe in words exactly what they believe are the boundaries of the invention. These claims are the primary focus of competitors in determining whether they might infringe the patent and the language and meaning of the claims is often the central focus of patent litigation. The application is submitted to patent offices and there is an interaction with the patent examiners who make a determination whether various requirements are met, including that there be a meaningful difference between the claimed invention and the prior art in the field. Several years after the application is filed, if one has been successful, a patent issues.

The problem with the unique US requirements is that a patent application that is intended to meet European requirements will not necessarily meet US requirements. Worse, the issues in question are not necessarily visible during the process of applying for patents and probably will not be spotted by the US patent examiner. Rather, these issues arise in litigation when one tries to enforce one’s patent in court.

Here are two that are particularly tricky. European and US patent laws require that a patent application include a sufficiently complete and detailed description of the invention to enable a typical individual practicing in the field to himself implement the invention. Thus, if one has developed a biotechnology invention, for example, one typically provides a sequence listing and details the expression systems. In a software-related invention, one details the operation of the various software components.

In the US, however, there is an additional requirement that is not present in European patent law. That is a requirement that the application not only provide a sufficient description but that it describe what the individual inventors believe is the best way of carrying out the invention. Thus, if the inventors believe there is a particular technique or substance that is better than other ways of carrying out the invention, that should be disclosed in the application. If it isn’t, and if, during patent litigation, the other side discovers that the best way or "best mode" was concealed, the patent can be invalidated.

Another unique US requirement relates to the duty of disclosure to the patent office. In both Europe and the US, one typically describes in the patent application what is new and different about one’s invention from the technology that is otherwise available, called the "prior art." Thus, again, in biotechnology, one might explain that one is the first to invent a recombinant substance, or in energy, one might explain what efficiencies one’s invention brings as compared with conventional systems.

In the US, however, there is an additional requirement. In the US, one has an affirmative duty to disclose the important or "material" prior art that one is aware of. If one doesn’t disclose this prior art, and, again, if this is discovered in litigation, issues will be raised about whether this nondisclosure was intentional. A finding that material prior art was intentionally not disclosed to the patent office leads to a finding that the patent is unenforceable.

One can debate whether or not these are beneficial requirements from the policy standpoint; my point is not to justify these aspects of the US system. Rather, my point is that if one wants to protect one’s intellectual property on a global basis, one needs to be aware of these requirements and institutionalize compliance with them in one’s IP program.

Let me mention one other increasingly important aspect of the US patent system. Because of recent court decisions, the scope of inventions that can be patented has dramatically expanded. In particular, methods of doing business, which for many years were thought not to be patentable, have now been held to be patentable. This has unleashed a tremendous wave of patent applications, especially as new models of doing business using the Internet are developed. One example is a patent that is the subject of a new lawsuit, which claims a particular method of interacting with a web site to perform on-line shopping. There is no contention that this represents any kind of technical achievement, and no description of any technical achievement in the implementation of this method. This business methods issue is particularly important for e-commerce companies and financial institutions.

Let me conclude with a final recommendation about intellectual property protection. This is a structural recommendation about how intellectual property matters are handled in a modern high-tech company. Traditionally, intellectual property matters are the province of a patent department, which is often an isolated group with little access to senior management and little strategic focus. I have argued that it is important to have a coherent IP strategy. In such a strategy, resources are allocated on a basis to maximize return, necessary support from scientists and engineers in the company is obtained, and the overall patent strategy is consistent with the company’s larger strategic objectives. To develop and implement such a strategy, intellectual property should be treated like other strategic functions such as marketing or business development.

Let me conclude by reading from a New York Times review of a new book, Rembrandts in the Attic:

"The authors, Kevin G. Rivette and David Kline, emphasize the strategic importance of intellectual property by giving example upon example in which patents (or their lack) have been crucial to the fortunes of such companies as Texas Instruments and Kodak. They urge companies to follow the example of Xerox, which was smart enough to learn from its legendary failure to patent a graphical user interface that later became the basis for Apple’s Macintosh and Microsoft’s Windows operating systems. G. Richard Thoman, the current chief executive of Xerox, was hired in part for his intellectual property savvy, Mr. Rivette and Mr. Kline write. By contrast, they say, ‘most businesses today still concentrate patent responsibilities in the legal department -- the one group in the company, ironically, that is specifically not trained to make business decisions.’"