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Addressing a supply chain crisis: the looming tidal wave of third-party IP liability lawsuits

The seismic shift

Over the last 50 years the fundamental determinants of value in the global economy have changed. Most prominent in this shifting economic landscape is the category of intangible assets of all forms including patents, trade secrets, copy and data rights, and brand value. Over a short period of time, the importance and relative value of intangible assets has reached an unprecedented level. For example, in the last four decades intangible assets have gone from making up 17 percent to making up 84 percent of the S&P 500’s market value. ((John Wiley & Sons, Inc., Intellectual Property: Valuation, Exploitation, and Infringement Damages 7 (2018 ed.).)) This trend looks to only continue–if not intensify.

This is not intended to be a deep-dive into intellectual property. Given the assumption that IP will continue to dominate the economy, this article will analyze one of the inevitable effects of an IP-dominated economy: a tidal wave of third-party IP lawsuits and risks. It will observe is the cold reality—the pragmatic, on-the-ground importance—that companies are going to continue to face with third-party IP lawsuits. Again, we are not dealing with valuing intangible assets or understanding how intangible assets effect present or future value. This article is more focused on supply chain management. Companies rely on a vast array of suppliers to make and deliver products and these suppliers rely on intangible assets to meet their commitments. If a supplier violates or is even accused of violating intellectual property laws, the entire supply chain can be disrupted. This might be most pronounced in acquired IP portfolios as transcendent companies like Apple, Oracle, or Microsoft. 

Across the broader economy, the facts speak for themselves.

Greater than 80 percent of the economic value of the S&P 500’s companies is now linked to intangible assets. ((Bruce Berman, $21 Trillion In U.S. Intangible Assets Is 84% Of S&P 500 Value – IP Rights and Reputation Included, Ip CloseUp (June 4, 2019), https://ipcloseup.com/2019/06/04/21-trillion-in-u-s-intangible-asset-value-is-84-of-sp-500-value-ip-rights-and-reputation-included/.)) Amazingly, the US patent office issuance reached the 10 million level in 2018. It took over a century-and-a-half to reach the first five million patents, but just 27 years to reach the next five million. ((Nilay Patel, The US Patent Office has issued 10 million patents, The Verge (June 19, 2018, 12:59 PM), https://www.theverge.com/2018/6/19/17478898/uspto-utility-patents-10-million-issued.))

In CEO circles and around the c-suite, the successful development of intellectual capability as a competitive weapon has gone from merely interesting to being vital in the battle for superiority and relevance.  It seems undeniable that the development of intellectual property in the form of patents and trade secrets is fundamental to the development and evolution of a successful company. ((See R. Mark Halligan, Protecting Trade Secret Assets in the 21st Century, Landslide, Sept.-Oct. 2013, at 12, 13.))

You inevitably own the sins of your partners—and they can kill you

For companies of all shapes and sizes, one critical and potentially crippling derivative result of this new economic reality is the inherent increase in supply chain disruption and volatility caused by third party intellectual property lawsuits and claims. The stakes appear to be monumental for virtually all companies. For the largest companies in the world, anticipating and managing this legal risk may well be a major determinant in meeting financial objectives. For the 96 percent of all companies in the US that make less than $10 million in annual revenue, surviving patent litigation, with an average cost of $3 million, may prove existential. ((See, e.g., John Jarosz et. al, Analysis Group, US Patent Litigation Trends: More Patents, Lots of Litigation, Iam (Sept. 26, 2018), https://www.iam-media.com/patent-damages-us-courts-overview-current-state-play; PwC, 2018 Patent Litigation Study, IPWatchdog (May 2018),  https://www.ipwatchdog.com/wp-content/uploads/2018/09/2018-pwc-patent-litigation-study.pdf.)) 

The problem companies face is stated simply enough. The key issue is protecting against liability of suppliers that companies either acquire outright, or whose parts or technology they use as part of their supply chain. This issue can prove challenging to solve, especially if not dealt with head on.

There are plenty of cases that demonstrate the challenges faced by companies. One case in which a company got into trouble because of its supply chain was In re LeapFrog Enters., Inc. Securities Litigation. ((527 F. Supp. 2d 1033 (N.D. Cal. 2007).)) In that case, LeapFrog shareholders sued the company because it did not deliver on its projected financial numbers.

More relevant for our analysis is why LeapFrog was in the position to be sued in the first place. Essentially, the shareholders’ allegations hinged on LeapFrog’s supply-chain infrastructure being “inadequate and that its third-party logistics providers had numerous problems and issues shipping products properly or timely.” ((Id., at 1044.)) This highlights why many companies are bringing supply chain management in-house. Better management, control, and vigilance is seen as a benefit in the ever-increasingly litigious field of supply chain-related IP matters.

As the number and size of these lawsuits increases, it is clear they are not going to go away. For example, the ten largest settlements, jury awards, and general IP litigation losses of all time add up to almost $14 billion. ((See, e.g., Vipin Singh, 9 Blockbuster Initial Patent Damages Awards in the US, GreyB (last accessed, Feb. 2, 2020)

https://www.greyb.com/largest-patent-infringement-awards/.)) That is more than the GDP last year of one-third of the world’s countries. ((GDP Ranked by Country, World Population Review (last accessed, Feb. 2, 2020) http://worldpopulationreview.com/countries/countries-by-gdp/)) The size of settlements and resolutions that have occurred demonstrate just how insidious they are.

The “charge of the light brigade” – the current defense is inadequate

The famous poem by Alfred Tennyson paints the picture well. ((Alfred, Lord Tennyson, Charge of Light Brigade, Poetry Foundation (https://www.poetryfoundation.org/poems/45319/the-charge-of-the-light-brigade.)) Undermanned forces charging onto a battleground that is more treacherous than they could have ever imagined. Lines of defense can be drawn; however; they remain underdeveloped and must be bolstered to adequately address this growing challenge and avoid catastrophic volatility.

One of the lines of defense is the business process defense – of “defending the house.” Taking this approach, businesses try to optimize operational plans by way of supply chain management. Thus, companies take management of their supply chains in-house. But this approach has a tendency to raise more problems. “A global supply chain for sure has an impact on the success of a product; however, it also makes a company susceptible to land into patent litigation.” ((Nitin Balodi, Supply Chain Management: How to Use Patents for Risk Mitigation and Strategic Negotiations, GreyB (last accessed, Feb. 2) https://www.greyb.com/supply-chain-management-patents-risk-mitigation/#.)) Unlike in the past, where a business might acquire a factory and the liabilities that came with it were (relatively) more transparent, this may not be the case when it comes to acquiring IP.

An article published by Greyb, an intellectual property services consultant, echoes what some in management and in intellectual property circles are beginning to understand.

“A normal patent risk mitigation strategy helps you tackle litigation in the courtroom,” ((Id.)) writes Nitin Balodi. With the looming tidal wave of third-party IP liability suits, the strategic advantage for businesses will be to avoid the courtroom in the first place. “[A] smart patent risk management strategy can help eliminate the threat beforehand in a way that you find no need to go to a courtroom.” ((Id.)) In essence, increased cooperation between internal legal departments and operations teams can help companies cope with increasing challenges. ((See id; see also National Research Council, Chap. 3, Surviving Supply Chain Integration 27-28 (2000), https://www.nap.edu/read/6369/chapter/5#28.))

Yet, there is also a way to treat what might otherwise be viewed as risk as an opportunity. And this translates to IP risk. Just as manufacturers have worked together to increase the efficiency of their supply chain strategies, ((see generally, id.)) companies that are more professional services-oriented can do this with their IP, too.

Emphasizing supply chain management, and refining supplier requirements are some ways businesses may start looking to diminish their IP risk when it comes to their supply chains. For example, GreyB, the IP services consultant mentioned above, centralizes the outline of strategies that a lot of businesses are undertaking to manage their IP liability in their supply chains. One example of this is a useful matrix that helps facilitate internal strengths, and external threats and opportunities. ((See Balodi, Supply Chain Management. )) Of course, specifics are tailored to each company.

Further, taking a taxonomy-based approach is seen as another potential way for businesses to safeguard their supply chains against IP infringement threats. This maps up- and downstream suppliers’ patents. This accomplishes several purposes. Most important, it helps a business understand where it is exposed to IP risks. ((See id.))

Another way that businesses have started to address these risks is by leveraging external balance sheets. Third-party capital and insurance balance sheets play large roles in this effort. On this front, IP valuation is critical. For example, requiring all suppliers meet a specified set of requirements that will qualify them to independently purchase specialized insurance to cover intellectual property liability will likely reduce substantially the potential volatility. This option is just beginning to become available and will be another “tool in the tool kit” to address this challenge.  

New capability combined with organizational change will determine success

Here is the punch line: The ability to understand, anticipate, and actively manage supply chain risk directly linked to IP liability is rapidly becoming a required competency to achieve and sustain economic success in this new reality.  Connecting operating strategy and legal strategy has never been more important. The complexity of this remedy stems from the requirement to both improve content and evolve organization leadership to a more integrated and coordinated approach.  This demands top down direction and commitment to make a difference. Absent progress, risk will grow and the introduction of greater volatility is a certainty.

Legal departments have to be more integrated with the business, with their roles becoming more influential than ever before. If different teams within companies’ core functions operate together, they will be in better shape to understand risks and to execute to take advantage.