On August 29, 2013 Deputy Attorney General James Cole issued a memo concerning enforcement of the Controlled Substances Act “in light of state ballot initiatives that legalize under state law the possession of small amounts and provide for the regulation of marijuana production, processing, and sale.”1 The memo noted that “the federal government has traditionally…
Tag: Litigation
Marijuana and Banks
On January 23, Attorney General Eric Holder announced that the federal government was taking steps towards making it easier for depository institutions to do business with marijuana sellers.1 Holder cited “public safety” concerns noting, “substantial amounts of cash just kind of lying around with no place for it to be appropriately deposited is something that…
Volcker Rule Revised in Response to Concerns of Smaller Banks
On December 10, 2013, five agencies, the Board of Governors of the Federal Reserve Board (“Federal Reserve”), the Commodity Futures Trading Commission (“CFTC”), the Federal Deposit Insurance Corporation (“FDIC”), the Office of the Comptroller of the Currency (“OCC”), and the Securities and Exchange Commission (“SEC”), promulgated a 71-page Final Rule to implement the Volcker Rule…
Experience and Logic?: The Strine Decision
The Strine Decision On October 23, 2013, the Third Circuit Court of Appeals declared the Delaware Chancery Court’s arbitration system unconstitutional.1 The arbitration system at issue was codified in the Delaware Code2 as well as the Rules of the Delaware Court of Chancery.3 Delaware’s program, established in 20094 provided for arbitration by a Delaware chancery…
Another Look at JPMorgan’s $13.1 Billion Settlement
Recently, JPMorgan Chase (“JPMorgan”) negotiated a tentative settlement of a record $13.1 billion with the U.S. Justice Department over mortgage lending practices.1 While some news outlets have portrayed this as politicized government overreach or anti-Wall Street zealotry2, others have argued that the government could (or should) have forced JPMorgan to pay “significantly more than thirteen…
Private Equity Firms Accused of Misleading Buyer
Japanese beer and beverage maker Asahi Group has filed a lawsuit in Australia against two private equity firms who sold Asahi a liquor company for $1.3 billion USD. The suit claims that Australian-based Pacific Equity Partners and Hong Kong-based Unitas Capital—the previous owners of New Zealand’s Independent Liquor—presented inflated earnings figures during the sales process.[1] As a result of this “misleading and deceptive conduct,” Asahi feels that it grossly overpaid for the premixed cocktail distributor and that it deserves compensation.[2]
At the heart of Asahi’s complaint is the allegation that Independent Liquor’s earnings before interest, tax, depreciation, and amortization (EBITDA) figures were embellished.[3] EBITDA is often used to value a company for purposes of buying it, and has been called the “single most important financial contributor to buyout performance.”[4] The complaint alleges that Independent used creative accounting techniques such as ‘channel stuffing’—“a practice where a supplier forward sells stock on extended terms to retailers in order to account for significant ‘one off’ sales in a particular period”—to wrongfully include income and exclude expenses.[5] Asahi claims that these practices inflated Independent’s EBITDA by $NZ42 million,[6] and made it appear as if Independent was growing at the time of the sale when normalized calculations show that it was actually declining.[7] These inconsistencies likely had a significant impact on the negotiated purchase price, as Asahi claims it “conducted due diligence thoroughly and in good faith and relied on [the EBITDA figures] provided.”[8]
Although this dispute will be resolved in an Australian court, it is factually similar to a case arising out of Delaware a few years ago. In ABRY Partners v. Providence Equity,[9] the buyer, ABRY Partners, accused the private equity seller, Providence Equity Partners, of knowingly presenting a portfolio company’s misstated financials in connection with a sale.[10] The purchase agreement contained provisions designed to insulate Providence from liability for representations made by its portfolio company.[11] Specifically, the warranty that ABRY claimed was breached was “by its plain terms . . . [a warranty] made only by the [portfolio company] and not by [Providence].”[12] The agreement also contained a $20 million indemnification cap.[13] The Delaware Court of Chancery ultimately found that the indemnification cap would be honored if Providence did not lie.[14] However, it found that ABRY could collect damages in excess of the cap if it could prove that Providence knew its portfolio company made false representations or if Providence itself made such representations.[15]
If the Australian court takes a similar approach, the purchase agreement will be crucial in determining the level of culpability Asahi must prove and the amount of damages that they can recover. ABRY suggests that a properly drafted agreement can insulate PE firms from fraud committed by their portfolio companies in connection with the sale as long as the firm was not aware of it. If such a term were contained in this agreement, it would force Asahi to prove that these companies knew Independent was manipulating the EBITDA figures. While this is a seemingly heavy burden, the Asahi complaint suggests that they would be able to prove knowledge through email correspondence they have obtained.
Regardless of the outcome, this case evidences the importance of (1) conducting thorough due diligence; (2) understanding ways in which EBITDA can be manipulated; and (3) thinking carefully about future liability when drafting purchase agreements.
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[1] Neil Gough, Asahi Sues 2 Private Equity Firms Over $1.3 Billion Deal, N.Y. Times (Feb. 14, 2013, 5:13 AM), http://dealbook.nytimes.com/2013/02/14/asahi-sues-2-private-equity-firms-over-1-3-billion-deal/.
[2] Id.
[3] Asahi Alleges ‘Channel Stuffing’ At Beer Firm, The New Zealand Herald (Feb. 18, 2013, 11:45 AM), http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=10866101.
[4] Nicolaus Loos, Value Creation in Leveraged Buyouts 229 (2006).
[5] Adele Ferguson, Japanese Brewer Up in Arms Over Purchase Price, Newcastle Herald (Feb. 26, 2013, 5:00 AM), http://www.theherald.com.au/story/1326151/japanese-brewer-up-in-arms-over-purchase-price/?cs=9.
[6] See id.
[7] Asahi Alleges ‘Channel Stuffing’ At Beer Firm, supra note 3.
[8] Gough, supra note 1.
[9] ABRY Partners V, L.P. v. F & W Acquisition LLC, 891 A.2d 1032 (Del. Ch. 2006).
[10] See Ruling in ABRY Partners v. Providence Equity Case Has Lessons for Buyers and Sellers, Goodwin Proctor LLP (Mar. 14, 2006), http://www.goodwinprocter.com/~/media/Files/Publications/Newsletters/Private%20Equity%20Update/2006/Ruling_in_ABRY_Partners_v_Providence_Equity_Case_Has_Lessons_for_Buyers_and_Sellers.pdf.
[11] See id.
[12] ABRY Partners, 891 A.2d at 1042.
[13] See Ruling in ABRY Partners v. Providence Equity Case Has Lessons for Buyers and Sellers, supra note 10.
[14] See id.
[15] See id.
Intellectual Ventures
On September 24, “invention firm” Intellectual Ventures announced the first major legal settlements in firm history, resolving separate patent infringement litigation claims against memory chip companies SK hynix Inc. and Elpida Memory, Inc. for undisclosed sums. [1]
These events mark a rare public event for the secretive firm, which touts itself as the designer of the invention capital market. Founded by Microsoft executive alums Nathan Myhrvold and Edward Jung, Intellectual Ventures purports to be the first major player in the monetization of invention and in what its founders deem “Invention Capitalism”, a medium through which they hope to “make research something you can invest in.” CEO Myhrvold believes that creating this market for invention capital will radically alter the innovation landscape, “turbocharg[ing] technological progress, creat[ing] many more new businesses, and chang[ing] the world for the better.” [2] Such an undertaking would ostensibly require the firm to build a system where infringed-upon patent designers could connect with service providers (such as Intellectual Ventures) who would ensure that the inventors are being adequately compensated for their patent designs, subsequently incentivizing future inventors to continue their innovative pursuits.
Belying such lofty goals, though, is the firm’s business record to date, bringing to mind a much more mundane and nefarious notion than the firm’s stated mission—that Intellectual Ventures is simply the latest, and largest, in a long line of mega “patent trolls”. Though the firm has designed in-house some of the patents it holds in its portfolio, it is considered an NPE, or nonpracticing entity—a kind of entity that holds patents but does not manufacture corresponding products. The firm has not disclosed the size or content of its patent portfolio, but one study estimates that the firm has acquired from 30,000 to 60,000 patents through over 1,200 shell companies from individual inventors, corporations, governments, research laboratories, and universities (as of May 2011).[3] Such a total would place Intellectual Ventures among the 15 largest patent portfolio holders worldwide—a space previously dominated solely by tech juggernauts such as Microsoft and IBM.
Companies utilizing Intellectual Ventures’ services can receive access to the firm’s patent portfolio and license patent rights to quell infringement concerns when manufacturing their own technological products. The firm also markets a program called “IP for Defense”, through which Intellectual Ventures’ investors such as Verizon (who purchased an equity stake in the firm of $350 million) have utilized the firm’s patent portfolio as part of a litigation defense strategy. Faced with a pending infringement suit from TiVo, Verizon purchased a patent from Intellectual Ventures, subsequently utilizing the patent as the basis for a counterclaim in the TiVo suit. Despite the cries of Intellectual Ventures to the contrary, such practices are often considered an encumbrance to innovation rather than a vehicle for it, allowing non-inventors (such as Intellectual Ventures) to collect, or threaten to collect, a disproportionate return on patents while adding little value to the final commercial product. [4]
But regardless of the firm’s true effect on innovation or the patent market, it has accrued a sizeable following amongst investors, with over $5 billion of assets now under management,[5] funded from a disparate group including the likes of Amazon, American Express, Sony, and the University of Notre Dame. [6] Myhrvold notes that the firm has been structured in a form resembling traditional venture capital and private equity funds, allocating monies received into at least five different internal funds, and receiving approximately a 2% management fee in addition to 20% on the carried interest derived from the firm’s business operations. [7] With their current funding level, Intellectual Ventures will need to generate an unprecedented level of revenue from their patent portfolio to be a viable investment in the venture capital space. Stanford academics Robin Feldman and Tom Ewing estimate that, assuming a 10-year investment lifetime, the funds need to yield a lifetime revenue expectation of “roughly $40 billion to be considered a minimally successful investment.” [8]
Such daunting revenue expectations, though, have not prevented Intellectual Ventures nor budding market participants such as Acacia Research Corporation, Transpacific IP Ltd., RPX, and Round Rock Research, LLC from continuing to acquire more patents for their growing portfolios. Though the firm’s secrecy and usage of third parties to carry out the bulk of its litigation activities obfuscate what its vision towards long-term profitability and innovation truly entails, its recent settlements with SK hynix Inc. and Elpida Memory, Inc. and 2010 suits filed against two other technology companies suggest that perhaps they are finally ready to shed more light on how the company plans on building a robust invention market. [9]
[1] Intellectual Ventures Resolves Patent Disputes with SK hynix Inc. and Elpida Memory, Inc. , Intellectual Ventures (Sept. 24, 2012), http://www.intellectualventures.com/index.php/news/press-releases/intellectual-ventures-resolves-patent-disputes-with-sk-hynix-inc.-and-elpid
[2] Steve Lohr, Turning Patents Into “Inventional Capital”, N.Y. Times, Feb. 17, 2010, at B1.
[3] Tom Ewing and Robin Feldman, The Giants Among Us, 2012 STAN. TECH. L. REV. 1, 5 (2012). http://stlr.stanford.edu/pdf/feldman-giants-among-us.pdf
[4] Id. at 1
[5] Intellectual Ventures Corporate Fact Sheet, Intellectual Ventures, http://www.intellectualventures.com/assets_docs/IV_Corporate_Fact_Sheet.pdf
[6] Ewing and Feldman at 9
[7] Id.
[8] Id. at 12
[9] Id. at 14-15