As a preliminary matter, crowdfunding is different from crowdsourcing. As its name suggests, crowdfunding involves the funding of a project by a large group of people, generally each investing small amounts. Crowdsourcing involves a large group of people contributing relatively modest physical or intellectual efforts to help achieve a larger goal.

There are two types of crowdfunding. The first is “project crowdfunding” popularized by Kickstarter, IndieGoGo, and others. Supporters contribute small amounts to finance a particular project. This is generally legal, especially when structured as a gift donation and not a purchase. But many innovators and their potential supporters would like to fund an ongoing firm and not just a single project. While this might be structured as a (micro)loan, many would like to use equity investments. I call this second type “enterprise crowdfunding.” It remains illegal under U.S. securities laws until the Securities and Exchange Commission (“SEC”) issues its final crowdfunding rules under the JOBS Act.[ii]

The U.S. Congress endorsed enterprise crowdfunding by including the CROWDFUND Act in the JOBS Act. Many assumed that the statute was addressed to the well-known project crowdfunding sites such as Kickstarter and IndieGoGo. But again project crowdfunding is already legal and did not necessarily need legislation. The JOBS Act provided an overall set of requirements for a legal pathway to enterprise crowdfunding, while mandating the SEC to promulgate the actual mechanism for it. Thus, enterprise crowdfunding will not be legal for use until the SEC promulgates its final rules.[iii]

At the same time, the JOBS Act mandates other changes in securities regulations that may make enterprise crowdfunding less appealing than other private financing options.[iv] The Act generally relaxed mandatory information disclosure requirements for “emerging growth companies,”[v] while raising the trigger levels for companies to become “reporting companies” with significant mandatory public disclosure requirements.[vi] Equally important, it expanded upon the general solicitation already available for private offerings up to US$1MM under Regulation D, Rule 504 to allow such advertising for the unlimited dollar amount offerings under Rule 506, the most popular Regulation D private offering “safe harbor.”[vii] It also created a new “Regulation A+” “mini-offering” of up to US$50MM.[viii]

Even as Congress was liberalizing existing private offering pathways, it erected significant regulatory hurdles to the new enterprise crowdfunding private offering exemption. This is understandable, as many commentators are skeptical of both enterprise crowdfunding and the JOBS Act as a means to enable it. Some are worried about the potential for fraud and abuse.[ix] Others worry that small-time “retail investors” who invest through crowdfunding in tech start-ups will not understand the dilution risks they face from later venture capital (“VC”) financing rounds.[x] But the upshot is that these hurdles may simply make the costs of enterprise crowdfunding too high for firms that might benefit from it.[xi]

Notwithstanding these criticisms, enterprise crowdfunding will become a reality sooner rather than later, and tech start-ups will be among the first to explore using it. Yet no one appears to have written about the effects of enterprise crowdfunding on start-ups’ intellectual property (“IP”) strategies. Because IP is arguably the most important asset a start-up holds, this relationship is worth considering. This blog post provides preliminary thoughts about this topic.

Enterprise Crowdfunding Benefits for Start-Up IP Portfolios

Building an IP portfolio for a start-up is a long-term capital expense. Individual IP assets can arise from discrete projects, but the funding model for each project often does not include monies for IP procurement. Technology start-ups generally will have no revenue for a number of years while developing their products/services and business model. An IP budget is far down the list of expenses to be budgeted for, and will have to come from capital investments. VC-funded start-ups can usually budget for IP expenses, but those without such professional funding often cannot. Thus, the unfunded start-ups are the ones most keen on enterprise crowdfunding. Even angel funding may not be sufficient.

At the same time, start-ups arguably need patents even more than do established firms. Patents provide a critical tool in the David-and-Goliath competition they will have with larger incumbents in the field they seek to disrupt. Patents allow start-ups to appropriate the value of their R&D results by giving them legally enforceable exclusive rights that can be exercised against large incumbents seeking to copy the start-up’s innovations. Given the need for patents and other IP, start-ups desperately need funds to procure these rights. Project crowdfunding does not work unless the IP budget can be included in the overall project budget. Even where this can be done, the timelines of the project and IP procurement and enforcement will likely diverge and make it impractical from a reporting and accounting perspective. Enterprise crowdfunding would remove any uncertainty about the use of funds for IP procurement.

Risks of JOBS Act Enterprise Crowdfunding Disclosure Requirements on Start-Up IP Portfolio Development

The JOBS Act creates a new safe harbor private offering exemption for enterprise crowdfunding.[xii] The statute itself sets major parameters. The exemption covers only those offers and sales of a private issuer that raise no more than US$1MM investments capped for each investor by both absolute dollar amounts and as a percentage of the investor’s income or net worth. Crowdfunding issuers will have liability for material misstatements and omissions in disclosed material similar to that of IPO issuers. And crowdfunded securities will be subject to a one-year holding period, with limited exceptions. Issuers must use the private market intermediary portals mandated under the Act, but this means that such portals must be created.

Most important for my purposes, the Act imposes substantial disclosure requirements. Beyond basic information on the company and its capital structure, the Act requires disclosure of business, business plans, intended purpose and use of proceeds, risks, and a catch-all for any other information the SEC decides to require.[xiii] If other disclosure regimes under the securities laws are any guide, crowdfunding disclosure will be labyrinth and intrusive. There is a reason why many companies are choosing to stay private, or return to privately held status, especially after the increased disclosure requirements of the Sarbanes-Oxley Act of 2002[xiv] and Dodd-Frank Act of 2010.[xv]

Following the offering, the issuer will have to file annual reports with the SEC that cover the results of operations and financial statements. Issuers must then provide the reports to investors. Under the SEC’s proposed “Regulation Crowdfunding,” the SEC will require issuers to submit disclosures through the EDGAR system for public access.[xvi] This public disclosure element makes the crowdfunding exemption particularly problematic. Further, the SEC makes it clear that the point is to transform the process of regulated crowdfunding into a form of crowdsourcing:

The proposed rules are intended to align crowdfunding transactions under Section 4(a)(6) [of the JOBS Act] with the central tenets of the original concept of crowdfunding, in which the public—or the crowd—is presented with an opportunity to invest in an idea or business and individuals decide whether or not to invest after sharing information about the idea or business with, and learning from, other members of the crowd. In this role, members of the crowd are not only sharing information about the idea or business, but also are expected to help evaluate the idea or business before deciding whether or not to invest.[xvii]

Thus, the SEC clearly intends enough information to be made public about the issuer that a large number of potential investors can pore over, share, and compare details of its finances, management, business plan, and employees.

The crowdfunding issuer will become a kind of junior reporting company, yet without the experience and legal counsel of a company that makes it to a traditional public offering. By contrast, current Regulation D offerings require only the filing of Form D—which contains minimal information—with the SEC.[xviii] The more extensive disclosures required under Regulation D are made only to purchasers, and do not have to be public.

There are substantial risks for early stage start-ups to enter into a public disclosure regime. By contrast to IPO stage companies, early start-ups rarely have the specialized securities and IP counsel that can help them navigate the risks involved. Without such counsel, patentable inventions and trade secrets might be inadvertently disclosed—especially in the area of business methods—before applications have been filed and rights preserved. This is particularly true under the time pressure of ongoing periodic and material event reporting that can challenge even mature companies with in-house compliance officers.[xix] The likely place for such accidental disclosures will be in the mandated discussion of the firm’s business and financial condition discussion (compared by the SEC to the management’s discussion and analysis of financial condition and results of operation under Regulation S-K for reporting companies).[xx]

As the issuer becomes a junior reporting company, it will also have increased pressure to make other public statements. These disclosures can be the most perilous, especially where they include live remarks by company representatives (whether verbal or through social media). Descriptions of the company’s proposed products or services for purposes of soliciting support in the crowdfunded offering will present risks of enabling disclosures that could destroy patent rights. Part of engaging with the “crowd” may be a broad dialogue in which all manner of potential investors draw out responses from company representatives (official or otherwise) that disclose too much about the company’s plans and technologies. In fact, the SEC anticipates this happening and is already considering whether and how to make such disclosures part of the formal—and hence possibly liability generating—disclosures under Regulation Crowdfunding.[xxi]

In the event that potentially enabling disclosures of business methods or other inventions are made, the company will have to accelerate patent filing decisions. But without the funding to prepare and file a strong application (lack of funding presumably being a major driver of the crowdfunding offering), the company may have to file an inferior application, or no application at all. Thus, the crowdfunding effort may negatively alter the company’s IP strategy timeline.

Ultimately, the disclosure required under the crowdfunding exemption means that start-ups will need to retain expensive securities and IP counsel before starting the crowdfunding process. But if they could afford such counsel, they likely would not be engaged in crowdfunding. The downsides of mandatory disclosure and a broad investor base (that may or may not have voting power) should discourage companies from using this funding model unless they really need it.

Managing Crowdfunding Investors’ Expectations About Start-Up IP Portfolios

Beyond the disclosure issues affecting start-up IP strategies, crowdfunding generally presents issues for management’s interaction with shareholders. Publicly traded companies develop significant expertise and staff just to deal with a large, diffuse set of shareholders. Start-ups will be in no position to do this. Further, they may use crowdfunding to avoid professional investors such as VCs, even though those professionals often bring valuable expertise that can help the start-up manage a base of public shareholders.

Professional start-up investors understand the value of IP. They often know more than the founders about the realities and expenses of building IP portfolios with limited resources. Tough decisions need to be made about what to patent among competing promising inventions. Timing decisions for applications also require experience. Likewise, some inventions may be protectable as trade secrets. And in some industries, such as software, copyright will play an equal role with patents for protection of the core products developed. On top of all this, a strong brand—manifested through distinctive, federally registered trademarks—may play a more important long-term role than patents on any particular technology. Unsophisticated investors, who may constitute a large percentage of crowdfunders, will not be able to offer any help on these matters.

Even if some crowdfunders have such expertise, a start-up would need to bring them into a special confidential relationship to give them access to key inside information. But this could run afoul of fair disclosure concepts, which seek to have all outside shareholders on the same footing with regard to company information. Insiders who have access to nonpublic information are restricted in their ability to trade in the company’s stock. We do not yet know whether the SEC will treat a crowdfunded issuer as a kind of public company, which requires such insider-outsider distinctions for information dissemination.

Further, a crowdfunding raise early in a start-up’s life could deter professional investors from investing later. Many VCs lament capitalization tables bloated with too many friends and family investors. This means unpredictable votes on shareholder issues and more potential for litigation from early stage investors who get diluted in later rounds or disagree with the company’s direction and management.

Professional investors also usually understand the risks of IP portfolio value during the life of the company and in bankruptcy or dissolution. Even though significant amounts of money may have been spent on procuring patents, the portfolio may be worthless if the product or service it covers fails in the market. Of course, the portfolio may be monetized in other ways and experienced VCs may have guidance on that as well. But unsophisticated crowdfunders may wildly over- or underestimate the value of the start-up’s portfolio. This shortcoming, in turn, could put them at odds with company management in how to manage and monetize the portfolio.

In response, management may become more conservative in its decision-making—the worst thing for a disruptive start-up. Even then, crowdfunders may engage in litigation and other shareholder activism similar to that related to publicly traded companies. While this can provide helpful discipline to management of large entities, it may not be appropriate for early stage start-ups that need a lot of room to maneuver while exploring risky technologies and business models.[xxii]

Start-ups using crowdfunding will have to develop sophisticated investor relations functions, including investor education about the realities of IP portfolio development and management. Investors will need to know the high costs of patent procurement. They will have to learn that not everything will be patentable, nor will the company be able to patent everything that is patentable. At the same time, these investors will likely not have a say in this—and will not be privy to internal discussions affecting these decisions. Because of the perceived nature and rhetoric of crowdfunding, crowdfunders may be more inclined than public market retail investors to believe they have an active ownership role in the company—including a say in important management decisions. Finally, investors will need to know that expensive patents and impressive looking IP portfolios may turn out to be worthless in operation or bankruptcy.

Conclusion

The JOBS Act reduced the disclosure required for many forms of financing emerging growth companies. Yet, the crowdfunding exemption seems to impose heavier regulation and mandatory disclosures than other private offering exemptions. For a meager US$1MM raise, crowdfunded companies will become junior reporting companies. Despite this inferiority of crowdfunding to other funding avenues, it is expected that many start-ups will use it once the SEC promulgates the final rules. If it allows deserving start-ups to obtain funding they would not otherwise have received, then it may be worth it.

Start-ups that use crowdfunding, however, face a number of risks to their IP portfolio development. First, the public disclosure regime may lead to compromised IP assets. Second, to counter this, start-ups would need to hire expensive specialized securities and IP counsel that they cannot afford. Third, they will have a broad, diffuse and possibly unsophisticated shareholder base may not understand the high risk, tough decision environment of start-up IP portfolio development. Fourth, the demands and possible shareholder activism of such a shareholder base may force management to become far more conservative than is fitting for a disruptive start-up. Fifth, the company will have to incur the costs of developing sophisticated investor relations functions to manage shareholder expectations and provide education. The question is whether the financial benefits of crowdfunding outweigh these risks. More to the point, it may be that start-ups simply cannot afford crowdfunding because costs of managing it will outrun the US$1MM that can be raised.

Sean M. O'Connor is a  at the University of Washington School of Law. He holds a J.D. from Stanford Law School, an M.A. (philosophy) from Arizona State University, and a B.A. (history) from the University of Massachusetts, Boston. This post is based on the forthcoming article of the same name in the Symposium issue of the  on The Commercial Function of Patents in Today’s Innovation Economy co-sponsored with the . The Author can be contacted at mailto:soconnor@uw.edu.

The post Crowdfunding's Impact on Start-Up IP Strategy appeared first on IPOsgoode.

[IP Osgoode: Professor O'Connor's full article on this topic will be published in issue 24:1 of the later this year.]

Earlier on this blog, I posted a of the issues involved in the United States Supreme Court case of Board of Trustees of Leland Stanford Junior University v. Roche Molecular Systems, Inc. (“Stanford v. Roche” or “Stanford”).[2] Now that the case has been decided, I want to follow up on the decision and, more importantly, remaining open issues.

In line with my positions on the issues, the Supreme Court affirmed the United States Court of Appeals for the Federal Circuit (Federal Circuit) by rejecting Stanford’s argument that the Bayh-Dole Act is a “vesting statute” (such as the Atomic Energy Act, in which title to relevant inventions is vested in designated agencies by act of law). It also reaffirmed its earlier holdings that rights in an invention belong to the inventor, absent some express transfer between the inventor and his employer or another.[3] To reach these conclusions, it focused on the definition under Bayh-Dole which requires that a “subject invention” (those inventions subject to the provisions of Bayh-Dole) be an “invention of the contractor.”[4] Under the majority’s view, the emphasized portion would be superfluous if any invention arising under federal funding were subject to Bayh-Dole. Instead, the Court held that a subject invention is one to which the contractor lawfully has rights or title. Most importantly, the title allocation rules under Bayh-Dole, which leave the inventor with only a conditioned residual interest where neither the government nor the contractor elect to take title, only apply to subject inventions.

While the Court was constrained to the Bayh-Dole issue by Stanford’s petition for certiorari, a concurrence and a dissent expressed concern over the Federal Circuit’s holding on the VCA issue.[5] Under these views, the majority’s holding on the Bayh-Dole issue, combined with the Federal Circuit case law, provides opportunity and incentive for inventors—and contractors—to circumvent Bayh-Dole’s title allocation system. For these justices, the Federal Circuit’s 1991 ruling in FilmTec Corp. v. Allied Signal, Inc.[6] should be revisited.

In that case, the court asserted that the assignment of rights in an invention that does not yet exist is an assignment of an expectant or future interest and grants at most equitable title until the invention is actually made and a patent application filed.[7] However, immediately upon the filing of a patent application on the invention, legal title to the invention rights vests in the assignee with no further action required.[8] At the same time, actual assignments of expectant interests must be distinguished from mere obligations to assign rights in the future.[9] The latter are often used when the prospective assignee does not know in advance whether it wants title to the future invention and thus establishes what is essentially a call option. In contrast to the present assignment of future interests, when an obligation to assign is entered into and an invention is later made (and a patent application is filed), no transfer of title occurs until and unless the option is called. In the meantime, the inventor may legally assign any of her rights to third parties. Of course, if and when the holder of the call option calls it in, then the assignor will not be able to honor that option and convey the invention rights (unless she can reacquire them from the current assignee). At this point, she would be in breach of her option agreement. But the counter party to that agreement would only be able to sue for contract damages and not for an equitable remedy that would require conveyance of the inventions rights.

The FilmTec court did not state whether it was basing its decision on an application of state law—which normally governs contract law interpretation—or establishing a rule of Federal common law. This remained murky through later decisions,[10] until the 2008 decision in DDB Technologies, L.L.C. v. MLB Advanced Media, L.P.[11] In that case, the Federal Circuit squarely held that invention assignment agreements are governed by federal common law because they are integral to the question of standing in federal patent cases.[12]

The concurring and dissenting Supreme Court justices in Stanford seemed concerned as to both the rule that federal common law governs invention assignment agreements and that rule’s distinction between assignments of future interests and obligations to assign. Their concern appears rooted in how Stanford lost control of Holodniy’s rights and potentially jeopardized the Government’s rights in the invention.

But, when Holodniy executed the CPA, FilmTec had not been decided and at least one major California university system -- the Regents of the University of California -- appears to have believed that “agree to assign” effected an immediate transfer just as “hereby assign” did.[13] This, however, had been an incorrect understanding of the law, although the California state courts may not have cleanly addressed the issue until 1997. Once FilmTec was decided in 1992, though, all employers were on constructive notice that they should use the “hereby assign” language if they wanted to lock in a title transfer. If they continued not to use it, then they were either ignorant of the law or selecting the risk of the option agreement.

The bigger question is why some universities—including Stanford—continued using the “agree to assign” language even after FilmTec.[14] Holding aside the case where the universities might simply have remained ignorant about the state of the law, there are a few reasons why these universities may have chosen to take the risks of continuing to use the obligation to assign language. One is that the university will not know at the time of a researcher’s hire whether all, or even which, of her future inventions should be university property. Second, the university may (incorrectly) believe that it cannot take title to things that do not yet exist.[15] Third, the university may be confusing the federal tax exempt rules prohibiting the assignment of expectant interests by the entity to others with the permissible assignment of expectant interests from an employee or contractor to the entity.

All three of these are simply misunderstandings of the law. The first potentially remains a problem, but has three straightforward solutions. First, universities can use the “hereby assign” language in assignment agreements and then simply assign back inventions as needed. As an alternative to this, the agreement could have the researcher assign her future inventions to an escrow agent who would operate under the same rules as the university would use in later determining whether to take title to inventions as they arose. Then, as the inventions arose and were disclosed by the inventor to the escrow agent, the latter would apply the rules and assign the invention rights to the university or inventor, as applicable. Second, universities can craft a scope of future interests that have been presently assigned upon execution of the patent agreement. For example, the clause could state “faculty member hereby assigns all rights, title, and interest to future inventions developed in total or in part under federal funding agreements.” This could of course contain other factors, such as corporate sponsored research agreements. Third, universities can institute a “supremacy clause,” such as that upheld by the Delaware Court of Chancery in Cephalon, Inc. v. Johns Hopkins University.[16] In that case, Johns Hopkins required employees to include a clause in their outside consulting agreements stating that the outside entity agrees that the employee is under an obligation to assign her inventions to the university and that this obligations is senior to any invention assignments the outside entity might impose. In the case at issue, the researcher had done just that and the Court of Chancery upheld the validity and enforceability of this clause as against Cephalon. The challenge with this approach is that it is only as good as the diligence of employees in implementing it. Further, employees may not realize that assignment language may be in other kinds of agreements, such as the VCA in Stanford.

In the end, Stanford may be more important for what the Supreme Court did not decide than for what it did. The practice of relying on Bayh-Dole as a backstop to assignment problems should never have developed. Further, universities’ failure to adapt their agreements after FilmTec have left them vulnerable to the kinds of intervening conveyances that occurred in Stanford. However, these are entirely preventable provided that universities put in place appropriate assignment terms. Even if the Supreme Court overturns the Federal Circuit’s federal common law—as a general principle or specific to the assignment issue—this author is unaware of any state law that holds “agree to assign” language as having the same legal effect as “hereby assign” language. Thus, in the end, the debate over whether there should be federal common law on this point or not should be of no legal moment.

The post The Aftermath of Stanford v. Roche: Which Law of Assignments Governs? appeared first on IPOsgoode.

Traditionally, debates over the ownership and use of government funded inventions revolve around the interests of: the institutions that receive funding, the government, and the public. Of late, however, attention is being paid to the interests of inventors themselves. What rights do they have to compensation for their inventions, or to take the inventions with them if they leave the institution, or to assign or license the inventions to third parties? The latest installment of this fast growing area of interest is the case of Board of Trustees of Leland Stanford Junior University v. Roche Molecular Systems, Inc., for which the U.S. Supreme Court recently granted certiorari. In this blog post, I will discuss how a key assumption from the early days of U.S. Federal R&D patent policy led to a vexing conundrum for contemporary technology transfer law and policy that must now be resolved by the Supreme Court.

As U.S. Federal R&D spending increased dramatically in World War II, President Roosevelt charged the Attorney General to investigate the patent practices and policies of the various Federal agencies and their contractors. A report was released in 1947 and is mainly known for its recommendation of a “title policy” in which Federal agencies would be required to obtain title to inventions arising under government funding. This would apply equally to intramural research conducted by Federal employees and extramural research conducted by outside contractors. But the Attorney General also investigated the extent to which contractors were themselves securing title from their employees. Because Federal R&D contracts were generally between Federal agencies and institutions or firms, if those organizations did not secure title from their employees, then the organization would not be able to assign title to the government. The results showed that most private companies and nonprofit research institutions routinely secured IP assignments from inventive employees, but that many universities did not, especially in the case of faculty members. Notwithstanding this, the Report concluded that contractor employees were almost always obligated to assign their inventions to their employers. While this may have been true in the aggregate, it obscured the uncertain nature of university IP assignments (perhaps excusably because most practical development contracts were awarded to firms or research institutes). This then became the fundamental—but flawed—assumption that allowed the Attorney General expressly to limit his recommendations to allocating rights and obligations as between agencies and contractors only. Inventors’ rights and obligations would be left to contractors and their employees/independent contractors.

It was not until 1963, however, that any president acted on the Report’s recommendations with regard to extramural research (President Truman established formal policies with regard to intramural research patent ownership in 1950). But, President Kennedy’s “uniform” patent policy memo to departments and agencies was hindered by a number of ad hoc statutes Congress had passed allocating IP title in the case of particular technology fields—such as atomic energy—or with regard to specific agencies—including NASA. The Kennedy policy largely tracked the Report’s recommendations, albeit with a more nuanced title policy that allowed, on a case-by-case basis, for contractors to retain title or exclusive rights when needed to incentivize practical application of the research results. Following the Report, the Kennedy policy also restricted itself to allocation principles as between agencies and contractors (other than where dictated by the ad hoc statutes), and left inventors’ rights to the contractors. The policy did not affect contractor rights by operation of law, but rather had to be used to secure contractual rights by agencies in executing contractor funding agreements. It thus placed these issues squarely within the Federal procurement system.

Nixon largely reaffirmed these policies in 1972 and ordered that formal regulations be promulgated. Meanwhile, the National Institutes of Health and the National Science Foundation had already developed the institutional patent agreement (IPA) system that provided master agreements between those agencies and certain of their contractors to eliminate case-by-case title determinations. The IPAs established a default rule of title remaining with the contractor, with a license, march-in rights, and certain other protective rights granted to the government (all as originating in the Attorney General’s Report and adopted by both Kennedy and Nixon). However, the IPAs expressly required the contractor institution to secure patent title rights from employee inventors—perhaps because of an increased sense that the Attorney General’s assumption may indeed have been flawed. The government-wide regulations that issued also included such an express requirement.

When Bayh-Dole was passed in 1980, it likewise focused primarily on the allocation of title and rights as between Federal agencies and contractors (flipping the default title policy from the government to the contractor). Contractor employee inventors were addressed in two ways, both derivative of contractors’ rights. First, contractors must share revenues with employee inventors. Second, if contractors do not elect to take title to an invention, then the inventors may petition the funding agency to grant them title (rather than having it transfer to the agency). Bayh-Dole’s implementing regulations largely tracked the existing Nixon policy regulations, albeit with the default title rule change. This included the requirement that contractors must secure the government’s rights under Bayh-Dole by appropriate patent agreements with employee inventors.

Despite all this, a belief arose among many university officials that Bayh-Dole provided some sort of backstop title allocation mechanism as between a university and its employees, including faculty. The requirement to secure patent assignment agreements apparently came to be seen as one only to provide a formal path for perfecting assigned titles with the U.S. PTO. Thus, a failure to secure the assignment contractually from the inventor increasingly became viewed as a small matter—the inventor would “have” to assign the patent anyway under Bayh-Dole’s statutory provisions. Accordingly, many universities adopted a policy of having inventive employees sign future contingent assignment agreements based around the phrase “agree to assign,” rather than the immediate present assignment agreements favored by industry, which use the phrase “hereby assign.”

This has come to a head now in Stanford v. Roche. Stanford included the “agree to assign” language in its Copyright and Patent Agreement (“CPA”) that researcher Mark Holodniy signed in 1988. The following year, with Stanford’s knowledge (and apparently encouragement), he engaged in research at Cetus, a Stanford research partner whose PCR business and assets were later purchased by Roche. Holodniy signed Cetus’ Visitor Confidentiality Agreement (“VCA”), which used the present conveyance “hereby assign” language to effect the transfer title to all of Holodniy’s present and future inventions arising “as a consequence” of his work at Cetus. When the inventions were later developed, Holodniy and his co-inventors disclosed them to Stanford, which in turn filed a patent application resulting in the three patents-in-suit. Because Federal funding had been used in the Stanford lab, Bayh-Dole was deemed to apply and the university added in the required Government rights language to each patent. Along the way, Stanford duly required the inventors to assign the inventions, which each did. The issued patents list Stanford as the assignee.

When Roche began selling HIV assay kits based on the inventions, Stanford disclosed the patents-in-suit to it and offered a license. Base on Holodniy’s VCA and the fact that the techniques he learned and applied in developing the assay came from Cetus, Roche claimed that it had co-ownership, or at least a shop rights license (Stanford held joint title at least through the other Stanford researcher inventors), of the patents-in-suit and refused to take the license. Stanford sued and the trial court found, in part, that Holodniy could not have transferred any title to Cetus/Roche, because title had transferred to Stanford automatically, or by operation of law, under Bayh-Dole once the inventions arose. Roche appealed and prevailed, with the Federal Circuit ruling that the Bayh-Dole Act only regulates the legal relationships between Federal agencies and their contractors, and not as between inventors and the Federal contractor. The Federal Circuit held that because the Cetus VCA executed an immediate assignment of future inventions, it vested equitable title in Cetus before any title vested in Stanford. While Holodniy had signed Stanford’s CPA before signing the VCA, it only imposed a contractual obligation on him to assign inventions when they arose and at Stanford’s request. Thus, Holodniy essentially breached the CPA when he signed the VCA, because he assigned away the then future inventions and would not be able to fulfill his obligation to Stanford when the inventions later arose.

Stanford has presented the issue to the Supreme Court from a reverse perspective through a single question for certiorari:

Whether a federal contractor university's statutory right under the Bayh-Dole Act, 35 U.S.C. §§ 200-212, in inventions arising from federally funded research can be terminated unilaterally by an individual inventor through a separate agreement purporting to assign the inventor's rights to a third party.

But this question presumes that the “statutory right” under Bayh-Dole allows contractors to take title from any inventor who happened to develop an invention under the contractor’s Federal funding, or, alternately, that the Act automatically transfers such title by operation of law. From this presumption, Stanford asks whether the inventor can “terminate unilaterally” Stanford’s “statutory right” to the inventions. Bayh-Dole does not appear to work this way, however, and thus Stanford never acquired Holodniy’s title and nothing is being “terminated.”

It is true that Bayh-Dole envisions a system in which title allocation decisions are first made as between the contractor and the funding agency, with the inventor only being able to retain title afterwards in certain circumstances. And this system is jeopardized if inventors can simply assign their inventions to third parties before title vests in either the contractor or the government. But the system relies on contractors to secure title rights from inventors in the first place. At the dawn of Federal patent policies for extramural inventions, the exhaustive Attorney General’s Report concluded that contractors were already doing this and thus the government did not need to directly address that part of the equation. This allowed the Attorney General and subsequent presidential administrations from having to worry about constitutional and practical implementation questions with regard to a wide and complex field of contractor-inventor relationships (including students, staff, faculty, independent researchers, etc. at universities). Even amidst the extensive debate over Bayh-Dole and similar bills in Congress during the later 1970s and 1980, little to no mention was made of whether or how such a massive “automatic” title transfer from inventors to contractors would be authorized. By contrast, the extensive debates and detailed provisions of Bayh-Dole and its implementing regulations focus on the minutiae of how title and rights are to be allocated between contractors and the funding agencies. Bayh-Dole only provides two minimum requirements for how contractors should treat inventors. Its implementing regulations clearly require contractors to secure title from inventors by written agreement.

Congress likely has the power to pass a law effecting the automatic transfer of patent title from one party to another for all Federally funded inventions. The issue is that Congress does not appear to have done so in Bayh-Dole. The problem is that the practice of whether and how contractors secure title from inventors does not comply with the practice as found to generally exist by the Attorney General in 1947. This makes Bayh-Dole a potentially flawed law in its current state. It is beyond the scope of this post to outline how the law could be changed. The Supreme Court will soon let us know whether Bayh-Dole does in fact effect a massive, nearly unbounded transfer of title from inventors—who are essentially only third party beneficiaries of Federal funding agreements and thus not directly in privity with the government—to contractors. Universities complain that if it does not rule this way, then they will not be able to ensure that they can secure title to Federally funded inventions. But this is a disturbing claim as it means that they must not be able to ensure this for any other of their inventions either. Their licensees and assignees will surely be unhappy to hear this. At the same time, it simply seems to be an overblown claim. Universities are perfectly well able to secure the proper written agreements to protect their, and the government’s, rights, and they must do so under Bayh-Dole.

More details and analysis of this topic are available in both a report I co-authored for the U.S. National Academy of Science, , and Supreme Court I co-authored for the American IP Law Association (AIPLA).

The post Stanford v. Roche: the U.S. Bayh-Dole Act and Inventors’ Rights appeared first on IPOsgoode.

This is the second part of Professor O'Connor's feature blog post "Does Qualcomm's Value Chain Licensing System Survive Its Settlement With Broadcom?" Part one can be read .

Spring-boarding off the Quanta decision, Broadcom's declaratory judgment action argued that Qualcomm was misusing its patents to force upstream and downstream parties to license those patents in a "double recovery" or "double compensation" scheme.  Qualcomm's response was that the upstream and downstream parties were instead simply "sharing" the market value royalty in a beneficial diversification of the risk for either party, rather than either of them having to pay the full royalty and "collect" or "recoup" portions of it from others. 

As a preliminary point of analyzing the parties' claims, we should acknowledge that �ϳܲ��Գٲ�'����"substantial embodiment" and method exhaustion holding brought into starker relief the fact that Qualcomm will now be seen to be licensing at least some patent claims twice.  In other words, it is harder now for Qualcomm to argue that it is licensing only the chip claims to the upstream chipmaker (under the APLA), and only the system claims to the downstream handset maker (under the SULA). This means that Qualcomm arguably now can only assert that its licensing system is proper on the grounds that it can license the same thing to two parties.  While neither party raised the following in their filings, there must be an implicit argument that vertical multiple licenses are more questionable somehow than horizontal multiple licenses.  Clearly, a patent owner can license the same patent to multiple unaffiliated parties in horizontal relation -- i.e., multiple chipmakers. So the second issue is why there would be anything wrong with licensing the same patent to multiple vertical parties?

Broadcom argued that because there is/will be a sale of the licensed chips from the chipmaker to the handset maker, the patent is exhausted as to the sold chips and thus Qualcomm has no legitimate property/rights to use as consideration in contracting with the handset maker to enter a SULA.  To follow this out, if the handset makers are only, or primarily, entering into the SULA under pain of a patent infringement suit, then Qualcomm is misusing its patents because it is extracting value beyond the legitimate patent monopoly in the realm of the patent-exhausted, sold (or to be sold) chips.  Of course, this presumes that the handset maker could buy the chips from the chipmaker absent the SULA, which of course it cannot because of Qualcomm's restrictions on the chipmaker through the APLA.  But Broadcom was trying to argue that Qualcomm is still misusing its patents because it has taken both upstream and downstream parties hostage, in a manner of speaking, by setting out a double license situation that is take-it-or-leave-it for both upstream and downstream parties. This is somewhat persuasive if one thinks of the licenses as being offered/granted at different times, such that the first offered/granted should preclude the ability to demand the second on pain of patent misuse.  But, when presented as a kind of simultaneous grant/offer to both upstream and downstream parties that merely partitions the full market value royalty and license fees between then, the system does not seem so problematic.

While I don't see anything invalid or illegal with Qualcomm's upstream and downstream licensing system from a pure patent licensing perspective (I am not commenting on whether such a system could be viewed as anti-competitive in some circumstances under antitrust/competition law), I do think that Broadcom raised an interesting additional issue.  Because the authorized chip sales from the APLA licensed chipmaker to the SULA licensed handset maker are indeed likely subject to patent exhaustion, if the handset maker does anything with the purchased chips in contravention of the SULA, then Qualcomm's only legal action is likely limited to contract remedies, and not patent infringement remedies.  This is because Qualcomm does not seem to have required APLA licensed chip makers to engage in only conditioned sales of chips to SULA licensed assemblers (which would raise the question about whether Mallinckrodt is still good law).  Many of us had been focused on the fact that post-Quanta there was still nothing improper about limiting a manufacturing license sell/vend right to a certain category of purchasers (such as Qualcomm's APLA limitation on chipmakers to sell only to SULA licensed handset makers).  But that is a completely separate issue from the fact that once the authorized sale of chips to a SULA licensed handset maker occurs, then exhaustion has likely applied to any further patent claims for those sales/chips.  It is possible that a licensing system in which the manufacturer's sell/vend license is limited not just to a category of purchasers, but also to appropriately conditioned sales to those purchasers, would preserve the right of the patent owner to pursue patent infringement claims against a wayward downstream licensee.  This will depend on the continued validity of Mallinckrodt as good law. But as to authorized unconditioned sales, Qualcomm may only assert breach of contract claims for the wayward SULA licensee who turns around and resells the chips or otherwise operates outside the scope of the SULA.  This is not to treat contract remedies as inconsequential, but unless extraordinary relief is provided for in the contract, then remedies on par with potent patent remedies such as injunctions will be unavailable.

When the district court dismissed Broadcom's declaratory judgment action -- for want of an active case or controversy in part because Broadcom is not a party to an APLA or SULA, and was not actively being threatened with a specific patent infringement suit from Broadcom at the time -- that denied us the chance to get a direct ruling on Qualcomm's licensing system. But the hope for an appeal that might have kept the case alive has been entirely snuffed out with the Settlement Agreement that includes the out of court settlement of all active disputes between the parties, including any appeal of the declaratory judgment dismissal.  Further, the Settlement Agreement is quite clear that by its own terms it does not question or disrupt any other licenses and agreements that the parties have with third parties, with the exceptions of some limited third party beneficiaries that are largely either Broadcom's or Qualcomm's customers.  Thus, Broadcom has effectively dropped, and released forever, its claims against Qualcomm's licensing system.  Further, while I am uncertain because of the redactions in the publicly released version of the Agreement, it does seem that its terms preserve the contours of Qualcomm's licensing system even as to Broadcom and its customers (with the provisions for "exhaustive" and "nonexhaustive" licenses, with the former perhaps being similar to SULAs and the latter similar to APLAs).  At the same time, the major division -- especially as Broadcom sums up the terms of the Agreement in the text of the 8-K itself -- seems to be that Qualcomm gets the combined patent portfolio under the cross license only for cellular products, while Broadcom gets the portfolio only for non-cellular products.  Further, Qualcomm will buy a substantial number of Broadcom's patents outright through an assignment provision in the deal.

Presumably the Settlement was signed off on by the various courts involved. And ending this patent war is likely good for the telecommunications and chip manufacturer community overall.  But one does have to worry about the anticompetitive effects of both Qualcomm's licensing system and the division of the cellular and non-cellular market between the parties.  On the other hand, I am generally in favor of at least the value chain licensing part as I think it promotes commercialization over the increasingly long value chains presented by modern high tech commercialization pathways.  So on balance, I'm more concerned that the Settlement "stick" and not fall apart too soon.  I have been watching the Showtime series "The Tudors" on DVD recently and I have visions of the Broadcom-Qualcomm Settlement as yet another of the "grand alliances" variously among England, France, and Spain of the historical period that would be honored while convenient, and cast away when not.

The post Does Qualcomm's Value Chain Licensing System Survive Its Settlement With Broadcom? (Part Two) appeared first on IPOsgoode.

Qualcomm and Broadcom finally seem to have ended their long running, epic patent litigation war -- or at least executed a truce for the time being.  With battle fronts in the U.S., Korea, Japan, and the EC, this conflict has been a poster child for patent reform advocates.  But as a multi-jurisdictional affair, any reform lessons to be learned from it need be multi-jurisdictional as well.  My interest, however, is the effect (if any) the settlement will have on Qualcomm's hotly contested value chain licensing system that secures royalties from both upstream and downstream parties in the chip and handset manufacturing and distribution chain.  While many might have believed the U.S. Supreme Court decision in Quanta Computer, Inc. v. LG Electronics, Inc., 128 S. Ct. 2109 (2008), overturned the validity of such licensing systems under the doctrine of patent exhaustion, a careful analysis of both Quanta and Qualcomm's actual system refutes this easy assumption.

Because Broadcom deemed the Settlement and Patent License and Non-Assert Agreement ("Settlement Agreement"), executed on April 26, to be a material agreement under U.S. securities laws, it released a on April 29 as an exhibit to a SEC material event report on Form 8-K.  Qualcomm appears to have taken the position that the Settlement was not a material agreement to it, as it has not released even a redacted version even in SEC filings that mention the Settlement, such as its , the same day as Broadcom's 8-K filing.  Admittedly, Qualcomm is a much bigger entity than Broadcom, and thus under U.S. securities cases what is material to Broadcom in terms of value and scope of an agreement is not necessarily material to Qualcomm.  Nonetheless, because of the extent of the litigation across multiple jurisdictions, the distraction it provided to management, and the final settlement payments totaling US$891M, I might have expected Qualcomm to file the Settlement Agreement itself with its 10-Q that disclosed the existence and outline of the Agreement.

The Settlement Agreement is quite long and detailed, and the SEC-permitted redactions in the publicly released version obscure what may be some key terms and provisions.  Nevertheless, what seems fairly clear is that Qualcomm's licensing system remains intact as to everyone other than Broadcom and its customers.  And even as to Broadcom's customers, the Agreement makes distinctions as to "exhaustive licenses" vs. "non-exhaustive licenses", "cellular products" vs. "non-cellular products", and the existence or absence of "pass through rights" in different circumstances.  At the same time, Broadcom had earlier brought a declaratory judgment action against Qualcomm arguing that the latter's licensing system was illegal, especially in light of the Quanta decision.  The case was filed in the U.S. District Court for the Southern District of California as Broadcom Corporation v. Qualcomm Incorporated, Case No. 08cv1829-WQH-LSP (October 7, 2008). The case was dismissed without prejudice on March 12, 2009 based on the court's decision that Broadcom presented insufficient claims showing an immediate and actual case or controversy.  Thus, it did not rule on the merits of Broadcom's allegations that Qualcomm's licensing system was illegal.

So what is Qualcomm's licensing system?  Qualcomm described it in an amicus brief it filed in the Quanta case:

"Qualcomm has provided chipmakers nontransferable, worldwide, nonexclusive, restricted licenses to its portfolio of technically necessary patents through licensing agreements called ASIC Patent License Agreements ("APLAs").  Chipmaker-licensees typically pay Qualcomm an up-front license fee and a running royalty (paid quarterly) that is an agreed upon percentage of the defined Net Selling Price of the chips produced by the licensee.  As is common in the industry and has been found by the Court plainly to be within the rights of patent holders, see, e.g., Gen. Talking Pictures Corp. v. W. Elec. Co., 305 U.S. 124, 127 (1938) ("That a restricted license is legal seems clear.") (citing Mitchell v. Hawley, 83 U.S. (16 Wall.) 544 (1872)), the license that Qualcomm has granted in APLAs is limited in both scope and conditioned upon the licensee acting within the bounds of its limited license. An APLA provides the chipmaker-licensees with a license to make (or have made) its own ASICs [ed. "Application Specific Integrated Circuits"]. An APLA also provides the chipmaker-licensee with a restricted license to sell ASICs, but only to handset makers that that APLA defines to be an "Authorized Purchaser" for incorporation into fully assembled handsets.  Authorized Purchasers are those handset makers that themselves have a license from Qualcomm through their own Subscriber Unit License Agreement ("SULA") to make, use and sell fully assembled handsets that, in the absence of a SULA, would infringe Qualcomm's patents.  Importantly, by their express terms, APLAs do not grant a license to the chipmaker to use the ASICs--i.e., licensed chipmakers may not themselves use or pass on to others the right to use the chipmaker's ASICs to make, operate or sell handsets or any other product. APLAs explicitly state that the rights to use the ASICs to make, operate or sell handsets are only conferred by licensing agreements between Qualcomm and Authorized Purchasers (i.e., by SULAs). APLAs also expressly state that the license granted is only for the limited scope laid out, that no other license is granted or implied and that if the chipmaker-licensee sells ASICs to entities that are not Authorized Purchasers, the licensee has materially breached the APLA, which gives Qualcomm the right to terminate the agreement, including the license granted."

"As previously mentioned, producers of chips that are licensed through APLAs are granted, inter alia, a license to sell such chips only to handset makers that have entered into a SULA with Qualcomm. The standard terms of the SULAs have granted handset makers a nontransferable, worldwide, nonexclusive, unrestricted license to Qualcomm's patents to make (and have made), import and use handsets, and to sell (and offer to sell) completed handsets. SULAs typically provide for an up-front licensing fee to be paid to Qualcomm, along with a running royalty (paid quarterly) that is set as a percentage of the Net Selling Price of the handsets sold. The broad license typically provided in Qualcomm's SULAs exhausts Qualcomm's patent rights when handset makers sell finished handsets to their customers--typically wireless carriers such as Verizon Wireless--and pay Qualcomm the royalties due under the SULA. Qualcomm has not sought to license its patents to or receive royalties from wireless carriers or end users."

"Qualcomm is also in the business of developing and selling its own chips and software for wireless handsets. Qualcomm typically sells chips only to those handset manufacturers that are licensees to Qualcomm's patents under a SULA. Such chip sales are pursuant to Components Supply Agreements, in which handset makers agree to pay Qualcomm an agreed upon price for the chips sold by Qualcomm. Components Supply Agreements provide that the buyer-handset makers may only incorporate the chips purchased from Qualcomm into fully assembled handsets that are the subject of the SULA between Qualcomm and the handset maker.  The sale of Qualcomm chips pursuant to Components Supply Agreements does not provide the buyer-handset makers any license to Qualcomm's patents, and Components Supply Agreements expressly state that no patent license, express or implied, is granted by the sale of the chips or the Components Supply Agreement.  Rather, all patent licensing is covered by the SULA.  Components Supply Agreements contain a representation and warranty by the buyer-handset maker that the chips purchased pursuant to the Components Supply Agreement will be used solely to develop and manufacture handsets for sale subject to and in accordance with the SULA between Qualcomm and the buyer-handset maker."

Because this system allows Qualcomm to collect royalties on the same patents from both chip makers (under the APLA) and handset makers (under the SULA), it has been criticized by others and alleged to be invalid or illegal after the Quanta ruling, such as by Broadcom in its declaratory judgment action. But I think that the Supreme Court left exactly enough space in its Quanta holding for Qualcomm's system to remain valid.  Despite what I sometimes hear as an interpretation of Quanta that the Supreme Court invalidated all "double royalty", multiple licensing, or value chain licensing systems, it does no such thing.  The case instead turned on whether there was an authorized and unconditional sale of products substantially embodying the patents at issue. If so, then exhaustion applies and the patent owner cannot bring an infringement action against the purchaser of the product, or demand that it take a license.  In the LG-Intel license at the heart of the Quanta case, the parties had an unlimited license to make and sell chips embodying each other's patents. A separate agreement required Intel to notify its customers that it (Intel) had no authority to grant a license to them to use the chips.  Intel did so and thus complied with this separate agreement.  The problem was that the customers, including Quanta, realized that because Intel was fully licensed to make and unconditionally sell chips to them, the patents were exhausted upon such sale and thus no license was needed from LG.  The Supreme Court agreed with this position, but was quite careful to explain that this holding rested on the exact nature of the unlimited make and sell license.  The Court seemed to endorse some of its earlier holdings, such as General Talking Pictures (see above), that allowed for restricted or limited licenses to cut off exhaustion defenses by certain classes of end users or other downstream purchasers.  This rests on the need for the sale to be "authorized".  Thus, in General Talking Pictures, the patent owner licensed a manufacturer to make and sell amplifiers but only to amateur users and not to commercial users.  The Supreme Court in that case held that when the manufacturer knowingly made and sold amplifiers to commercial users as well (who also knew the license limitation on the manufacturer), these actions were the same as if the manufacturer were operating with no license at all (as to these sales). And because the sales were not therefore authorized, then the purchasers were treated as having knowingly purchased what were essentially counterfeit goods, and thus no exhaustion had occurred and the patent owner could sue them for infringement as well.

Accordingly, following Quanta, my advice to patent owners has been to make sure that they limit the scope of their licenses to only the activities and sales they truly wanted to authorize, with the understanding that whatever was authorized would then be subject to the exhaustion doctrine.  Essentially, this was just a reminder that the "make" ("have made"), "use" ("have used"), and "sell" ("have sold") patent rights are indeed severable and can be individually limited.  An open question is whether "conditioned sales" under the U.S. Court of Appeals for the Federal Circuit's decision in Mallinckrodt Inc. v. Medipart, Inc., 976 F.2d 700 (Fed. Cir. 1992) can still hold off the application of exhaustion to goods sold under those terms after Quanta.  But that could easily be the topic for another blog entry.  When asked whether Quanta "changed" the law as to any of this, I have generally said no.  Intel and LG's licensing counsel should have known that an unlimited make and sell right was an invitation for exhaustion claims by downstream purchasers when they established the cross license in the first place.  Yet, before we rush to judge them too hastily, keep in mind that any negotiated deal can have certain sticking points that the parties cannot resolve and the resultant memorialized agreement may intentionally contain vague or suboptimal clauses (from a legal perspective). And indeed at a conference in which I mentioned this very point in the context of the LG-Intel license, an audience member stated that he knew one of the attorneys involved and that there were indeed business and negotiation issues that precluded the use of what we as licensing lawyers would have seen as the optimal make and sell right grant language, given the goal to limit some downstream uses.

In the second part of this feature blog post, Professor O'Connor will examine Broadcom's declaratory judgment action and further discuss Qualcomm's value chain licensing system.

The post Does Qualcomm's Value Chain Licensing System Survive Its Settlement With Broadcom? (Part One) appeared first on IPOsgoode.