Litigation Risk -- Top 10 Challenges for Tech Companies After US Expansion

Fried Frank and leading UK VC firm Notion Capital have teamed up on a blog to offer their perspectives on transatlantic VC investment and considerations for UK and other non-US companies looking to raise VC funding from US investors. Check out the full series here.

Top 10 Challenges for Tech Companies After US Expansion – Part 4

This is the fourth part of our blog series addressing the top ten challenges that UK and European companies face after establishing an initial US presence.

Part 1 addressed various challenges relating to employees. Part 2 covered contracting with large companies and protecting key intellectual property. Part 3 addressed securing US investment.

This Part 4 focuses on management of US litigation risk – both generally and in the context of IP claims.

NO, NOT EVERYONE SUES ALL THE TIME, BUT ….

The Litigation Problem. Litigation risk is higher in the United States than in most other countries. There are a number of reasons for this. First, in general the US does not have the “loser pays” rule common in the UK and many other countries, whereby the loser in litigation bears a significant part of the winner’s legal fees. Consequently, relatively weak claims by plaintiffs have settlement value because the defendant’s cost of settlement may be less than the cost of the defending the claim. Plaintiffs (and their contingent fee lawyers) know this, and may bring claims they wouldn’t otherwise assert if they were at risk of paying the defendant’s legal fees.

Second, it is relatively inexpensive to bring litigation in the US. On the other hand, defending US litigation is expensive, not least because the scope of pre-trial discovery (not limited to document discovery) is significantly broader in the US than in most countries.

Third, because of wide use of jury trials in US civil cases, defendants are at greater risk that inexperienced jurors rather than experienced judges will assess the factual elements of disputes.

Fourth, it is relatively easier in the US than in most countries for lawyers to initiate “class action” litigation on behalf of masses of persons claiming to have been harmed in the same or a similar way.

Finally, government regulators are substantially more aggressive in the US than in most other countries, and more prone to mount extensive investigations and seek penalties (including criminal penalties) in enforcement actions.

As a result, the threat of litigation is a common tool of business negotiation in the United States, whether the potential claimant is an unhappy contractual counterparty, a disgruntled employee, a third party or class that claims to have been injured, or an aggressive regulator. While most of these claims settle before trial, they do impose substantial costs, particularly on defendants who may have to take weak claims seriously.

Pro-active management. So what does this mean for non-US companies entering the US market? It is crucial that companies manage this risk pro-actively, anticipating potential problems and addressing them before they arise. What this means obviously varies in the context, but it generally requires greater care – for example, in making sure that contracts accurately describe services and performance obligations, that HR matters are handled sensitively, that early indications of problems are taken seriously, and that regulatory and tax issues are addressed in advance.

Compliance. Additionally, some person or persons in your organization need to have clear responsibility for ensuring compliance with contracts, laws and regulations, and your systems need to permit appropriate tracking of compliance.

Insurance. Finally, it is critical that you obtain appropriate insurance advice from a broker with North American experience. You need to know what kinds of coverage (and with what limits) a company in your business might be expected to procure in the US. Some of these are mandatory (such as workers compensation insurance for your employees), some will be required by contractual counterparties (such as evidence of professional liability insurance, which in the US is generally referred to as errors and omissions insurance, or certain kinds of automobile coverage), some are highly prudent (such as directors’ and officers’ liability insurance), and some may depend on the nature of your business (such as employment practices liability insurance, IP liability insurance and cyber insurance). In any case, you can only reach appropriate conclusions as to what makes sense once you have obtained the advice, and you should revisit your conclusions at least annually.

THE WILD WORLD OF INTELLECTUAL PROPERTY CLAIMS

Intellectual property claims, primarily patent claims, are common in the United States, and they can be very expensive to defend. Most commonly, patent claims are brought by competitors who are trying to keep you out of the market or by non-practicing entities (less politely referred to as “patent trolls”) whose business model is based on buying up patents and then seeking license fees from companies whom they claim are infringing. In both cases, getting early particularized advice is important, but the approaches may be different.

It can be difficult to determine if you are infringing on the patent rights of others. Full patent reviews are very expensive, and unlikely to be definitive since one is trying to prove a negative. Typically, we would not recommend that emerging companies incur this expense. On the other hand, you can’t put your head in the sand either, because you are potentially subject to triple damages for wilfully infringing on the patent rights of others.

Competitors. Consequently, in circumstances where you have clear competitors, it is important to conduct appropriate due diligence to assess what patent rights they may have, and then reach some early conclusions, with professional advice, as to how you will address those potential claims. Of course, if you have your own patents on which your competitors may be infringing, you may have some currency with which to reach a sensible commercial conclusion on the issue.

Non-Practicing Entities. Patent trolls are simply looking for license fees. They may not pay attention to you while you are small, because they are looking for low-hanging fruit where they can get an easy, cost-effective return without much effort. As you gain public prominence in the US, however, you are more likely to hear from them. You will need assistance in evaluating their claims, and then need to reach a conclusion as to whether to resist them (perhaps together with other companies who are facing the same claims) or to settle for some amount.

Indemnification. Contractual counterparties in the United States, particularly large corporates, are likely to require you to indemnify them if your products or services should result in IP infringement claims against them. Given the expense of trying or settling IP claims in the US, this is a serious risk. It may be a fair ask if your products or services have caused the problem – it is not so fair, however, if, for example, the claim results from their combination of their products or services with your products or services, or if they have failed to implement a work-around that you asked them to install. Typically, their proposed IP indemnification provision will require negotiation in order to add appropriate exceptions. Additionally, you may want to consider procuring IP liability insurance to protect against IP risk, although it can be expensive and the policy language requires careful review.

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This discussion is not intended to provide legal advice, and no legal or business decision should be based on its contents. If you have any questions or comments, feel free to contact robert.mollen@friedfrank.com or via LinkedIn here.

You will find Bob’s other weekly blogs for emerging and growth companies on US issues, international expansion and early stage financing here: http://bit.ly/2lP5uMP