Winter 2012

Greetings!

Invotex® Group is pleased to share insights about current trends and issues of interest to litigators and counsel, particularly those with which we have recent experience. We hope you find this information informative, and we welcome your feedback.

In this Issue

1. Commercial
   Litigation Disclosures in Financial Statements – What’s the Fuss?
2. Intellectual Property
   Using Investments in Licensing to Meet the ITC’s Domestic Industry Requirement
3. Valuation
   Business Judgment and Accountability: Sometimes the Best Defense is a Good Offense. The Case for Fairness Opinions
4. Continuing Professional Education
   Upcoming Events

Commercial

Litigation Disclosures in Financial Statements – What’s the Fuss?
by Lyn Brown

The Financial Accounting Standards Board (“FASB”) has issued a Proposed Accounting Standards Update, Disclosure of Certain Loss Contingencies,^[1] that could dramatically impact how much a defendant must disclose in its financial statements.

All businesses issuing audited financial statements are required to disclose information concerning probable litigation losses of a material amount. These requirements were codified more than 35 years ago by FASB.^[2] In brief, these requirements include two judgments:

• First, a judgment as to the likelihood that a loss is probable, reasonably possible or remote, and
• Second, a judgment as to the estimation of that loss

For example, if a litigation loss is deemed both probable and estimable then an amount must be accrued for the loss and disclosure made in the financial statement footnotes as to the nature of the loss. [For additional guidance and examples related to Accounting for Contingencies, follow the link.]

Once issued, this standard was followed by auditing guidance in Statements on Auditing Standards No. 12,^[3] which provided guidance on the procedures an independent auditor should consider for identifying litigation claims and assessments. The auditing guidance acknowledged that an auditor ordinarily does not possess legal skills to make legal judgments and, therefore, should request that the client send a letter of inquiry to their lawyers.

In response, the American Bar Association (“ABA”) released a “Statement of Policy Regarding Lawyers’ Responses to Auditors’ Requests for Information” in December 1975 to guide lawyers in responding to their clients’ auditors while also protecting the confidentiality of lawyer-client communications.

This ABA statement of policy has been referred to as “the treaty” and has governed the client-auditor-lawyer dialogue since the 1970s. The FASB recently issued an Exposure Draft (“ED”) proposing changes to Disclosure of Certain Loss Contingences^[4] because, they state, “Investors and other users … have expressed concerns that disclosure about loss contingencies under the existing guidance … do not provide adequate and timely information to assist them in assessing the likelihood, timing, and magnitude of future cash outflows associated with loss contingencies.”^[5] The current ED was issued in July 2010 and it was anticipated that the new guidance would be effective for reporting periods beginning after December 15, 2010.^[6] However, it has been 18 months since the ED’s release, and the FASB has not yet finalized the changes. Why not?

Simply put, the FASB received 339 comment letters in which the majority of respondents did not support the proposed changes. The concerns generally expressed are that the enhanced disclosures proposed by the ED would:

• Significantly increase the costs of financial statement preparation
• Force an entity to waive attorney-client privilege and work-product protections and / or
• Provide prejudicial information to litigation adversaries that would hinder the entity’s defense in litigation^[7]

In addition, there is much to debate in the changes proposed in the current ED:

• It requires increased disclosure such as: the name of court, the date instituted, the principal parties, the factual basis alleged to underlie proceedings, the current status, the amount claimed by plaintiffs and / or the damages indicated by expert testimony
• It requires a new judgment and disclosures if a loss contingency is considered remote and if the outcome may have a severe impact on the financial position
• It requires, for every annual and interim reporting period, the client to perform and disclose reconciliation by class, in a tabular form, of all recognized (accrued) loss contingencies
• It does not address any of the difficulties left unanswered by “the treaty” in 1975. In its comment letter, the ABA stated, “…we do not at this time believe that the revisions proposed in the Revised Exposure Draft…would require any changes to the ABA Statement....”^[8]

The FASB has stated it will reopen discussions this year. “The Securities and Exchange Commission is keeping up its laser focus on the accounting and disclosure of loss contingencies as it performs routine filing reviews, still probing for more information when companies disclose ‘reasonably possible losses’ that exceed amounts they have already recognized.”^[9]

For more information, contact Lyn Brown.
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^[1]Financial Accounting Series, Exposure Draft, Proposed Accounting Standards Update, Issued: July 2010, Comments Due: August 20, 2010, Contingencies (Topic 450).
^[2]Accounting for Contingencies, Statement of Financial Accounting No. 5, Issued: March 1975.
^[3]AU Section 337, Inquiry of a Client’s Lawyer Concerning Litigation, Claims, and Assessments, Issued: January 1976.
^[4]Financial Accounting Series, Exposure Draft, Proposed Accounting Standards Update, Issued: July 2010, Comments Due: August 20, 2010, Contingencies (Topic 450).
^[5]Financial Accounting Series, Exposure Draft, Proposed Accounting Standards Update, Issued: July 2010, Comments Due: August 20, 2010, Contingencies (Topic 450), p. 1.
^[6]There was a prior version of the ED issued in June 2008. The current ED has incorporated some changes suggested by the Comment Letters received during the prior comment period which ended in August 2008.
^[7]FASB, Disclosure of Certain Loss Contingencies, Comment Letter Summary, p. 2.
^[8]ABA Comment Letter (No. 280), Financial Accounting Series, Exposure Draft, Proposed Accounting Standards Update, Issued: July 2010, Comments Due: August 20, 2010, Contingencies (Topic 450). dated September 20, 2010, p. 10.
^[9]“SEC Vigilant on Contingencies Accepts Aggregation,” Compliance Week, November 1, 2011.

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Intellectual Property

Using Investments in Licensing to Meet the ITC’s Domestic Industry Requirement
by Edward A. Gold and Abby J. Weinstock

As many intellectual property attorneys know, a patentee bringing suit at the International Trade Commission (“ITC”) must meet the “domestic industry” requirement before the ITC will award an exclusion order as a remedy for patent infringement. One path to meeting the domestic industry requirement is to demonstrate “substantial investment in [the patent’s] exploitation, including engineering, research and development, or licensing.”^[1] The last option in this path, licensing, has sparked recent questions regarding what expenditures constitute substantial investment in licensing to meet the domestic industry requirement.

The issue has recently been discussed in two decisions: the ITC’s 2010 decision in Certain Coaxial Cable Connectors (Inv. No. 337-TA 650) and, more recently, the ITC’s 2011 decision in Certain Multimedia Display and Navigation Devices and Systems, Components Thereof, and Products Containing Same (Inv. No. 337-TA-694). The findings in these cases, as discussed below, demonstrate that the Commission will look for production-enhancing licensing efforts focused on the specific patent-in-suit.

In Certain Coaxial Cable Connectors, the Commission issued guidance that “patent infringement litigation activities alone cannot form the basis of a domestic industry.”^[2] Instead, the Complainant must: a) show that each asserted litigation activity is related to licensing, b) show that these activities are related to the patent in question, and c) document the costs incurred for each activity.^[3] In Certain Multimedia Display and Navigation Devices, the Commission noted that while the Complainant may have been engaged in licensing activities, those activities related to a portfolio that included both asserted and non-asserted patents. “Where the complainant’s licensing activities and investments involve a group of patents or a patent portfolio, the complainant must present evidence that demonstrates the extent of the nexus between the asserted patent and the complainant’s licensing activities and investments.”^[4]

In Certain Multimedia Display and Navigation Devices, the Commission identified a number of factors it may consider when making a determination as to the existence of a nexus between a complainant’s licensing activities and the asserted patents. These factors may include:

• The total number of patents in the portfolio
• The relative value of the asserted patent(s) as compared to the portfolio as a whole (e.g., Does the asserted patent(s) relate to industry-standard technology? Is it a base or pioneering patent?)^[5]
• The significance of the asserted patent in licensing discussions and negotiated agreements, and
• The scope of the technology covered by the asserted patent(s) as compared to the portfolio as a whole

The Commission specifically noted in its opinion, “The burden is on the complainant to show that there is a nexus between its alleged licensing activities and an asserted patent.”^[6] Ultimately, the Commission opined that in this instance, “The evidence indicates a minimal role for the asserted patents in the [in-house licensing] activities in view of (1) the many patents that were being offered by Pioneer in its proposed license agreements and (2) the scope of the portfolio as compared to the narrow focus of the asserted patents.”^[7] The ultimate determination by the Commission was to reverse the ALJ’s finding that a domestic industry exists. This opinion was proffered by the Commission not only on the basis of the licensing activity, but also after examining the Complainant’s activities as a whole to determine whether they constituted a substantial investment under the relevant statute. The Commission concluded:

• “Indeed, Pioneer [the Complainant] has not presented any evidence of engineering, development, or research activities in the United States. Nor has Pioneer presented any evidence of ancillary activities in the United States, such as license compliance, licensee design assistance, or the like.”^[8]
• “The significance of royalties in evaluating whether Pioneer’s investment is substantial was disputed by the parties and the commentators. Although royalties received by a complainant can be circumstantial evidence that an investment was made, they do not constitute the investment itself.”^[9]
• “Finally, Pioneer’s activities, on the whole, reflect a revenue-driven licensing model targeting existing production rather than industry-creating, production-driven licensing activity that Congress meant to encourage.... Although our statute requires us to consider all ‘licensing’ activities, we give Pioneer’s revenue driven licensing activities less weight.”^[10]
• “Consequently, taken as a whole, we find that Pioneer’s activities relate only minimally to licensing the asserted patents in the United States. In light of this finding, we further find Pioneer’s activities to be too limited in light of its resources and the relevant market to be a ‘substantial’ investment under section 337(a)(3)(C).”^[11]

The findings in the cases discussed above demonstrate that the Commission’s position on the domestic industry requirement and investments in licensing may continue to evolve, and that a complainant should carefully evaluate its ability to meet the domestic industry burden before bringing a patent suit at the ITC.

For more information, contact Edward A. Gold or Abby J. Weinstock.
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^[1]http://www.law.cornell.edu/uscode/usc_sec_19_00001337----000-.html.
^[2]Remand Initial Determination on Violation of Section 337, in the Matter of Certain Coaxial Cable Connectors and Components Thereof and Products Containing Same (Inv. No. 337-TA-650), May 27, 2010, p. 3.
^[3]Id. at p. 2.
^[4]Commission Opinion, in the Matter of Certain Multimedia Display and Navigation Devices and Systems, Components Thereof, and Products Containing Same (Inv. No. 337-TA-694), July 22, 2011, p. 9.
^[5]Additional evidence that can be used to determine the relative value of the asserted patent(s) include whether the asserted patent(s) was discussed during license negotiations; whether the complainant has successfully litigated the asserted patent(s) in the past; whether the asserted patent(s) is infringed or practiced in the U.S.; and whether the value of the asserted patent(s) is recognized by the market in some other way. Id., at pp. 10-11.
^[6]Id. at p. 12.
^[7]Id. at p. 20.
^[8]Id. at p. 24.
^[9]Id. at p. 24.
^[10]Id. at p. 25.
^[11]Id. at p. 25.

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Valuation

Business Judgment and Accountability: Sometimes the Best Defense is a Good Offense. The Case for Fairness Opinions
by William J. Bavis

Are your clients risking liability as they complete their daily tasks? What is considered good business sense today may be considered a breach of fiduciary duty tomorrow. And, with today’s economic climate, that possibility is increasing. Fairness Opinions may be just the offense to prove fiscal prudence and to ward off the need for a defense.

Fairness opinions can serve as evidence that officers and directors have conducted a process that helped them fulfill their fiduciary obligations. Generally, a fairness opinion is a determination by an expert that a business transaction is fair from a financial point of view. In some cases, fairness may be based on non-financial criteria such as normal industry or business practices. The fairness opinion is the overall consideration of the facts and circumstances at the time of the business decision or action, combined with the opining expert’s judgment -- as an independent third-party and based on their experience in the industry -- that yields the finding of fairness. Experts offering fairness opinions do so based on procedures designed to give a balanced view of the subject transaction.

The Sarbanes-Oxley Era

The passage of Sarbanes-Oxley in response to corporate scandals a decade ago created a climate of increased attention on the overall concept of corporate responsibility. In particular, there has been an increase in the expectations for those who accept positions as officers and directors of not only public companies but also of private companies and even nonprofit organizations.

Because of the increasingly complex capital structures of private companies, ownership of private companies is no longer concentrated among one or two shareholders; multiple classes of stock, equity funds, mezzanine financing, and various forms of trust structures result in divergent interests in corporate transactions and, therefore, more stakeholders.

Nonprofits are also getting their fair share of attention from some state legislatures and attorneys general who have extended some SOX-like provisions to nonprofits and have increased scrutiny on these organizations.

Tough Economy

The spotlight on corporate responsibility has been further focused by the tough economic times we have faced over the past several years. There have been numerous professional liability claims against corporate fiduciaries associated with bankruptcies and business failures. Corporate fiduciaries face the risk that shareholders or other stakeholders will claim that a transaction unfairly dilutes their interests or fails to resolve a burden that threatens the long-term viability of the company or their investment.

One such case that got a lot of attention was Just for Feet, which filed for bankruptcy in 1999 and in which outside directors of the company agreed to personally pay more than $41 million to settle a lawsuit brought by the bankruptcy trustee. The directors were accused, among other things, of breaching their fiduciary duties and acting in bad faith by delaying the bankruptcy filing against the advice of outside experts. This settlement was one of the largest ever of its kind.

Business Judgment Rule

Officers and directors have long relied on the business judgment rule as a defense against fiduciary claims. As stated in Aronson v. Lewis, Del. Supr., 47 A.2d 805, 811 (1984), the business judgment rule “…is a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.”

In circumstances where the company’s fiduciaries are likely to be second-guessed about their ability to act on the behalf of all stakeholders, fiduciaries should pay careful attention to good processes, adequate information and proper analysis as a basis for their actions. Board members have a fiduciary duty of care that requires them to be reasonably informed when making specific decisions that may affect stakeholders who are not actively participating in the decision making. Independent analysis resulting in a fairness opinion is a powerful tool corporate fiduciaries can use to fulfill their responsibilities to all stakeholders and minimize their own risk.

For more information, contact William J. Bavis.

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Upcoming Events

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Disclaimer: The opinions expressed in this newsletter are the opinions of the individual author(s) and may not reflect the opinions of the firm or any other individual associated with the firm.