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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.

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In this Issue

1. Patent
   The Value of Financial Analysis in Patent Litigation Settlement Negotiations
2. Bankruptcy
   The Case for a Liquidation Trust
3. Valuation
   Must Business Appraisals Comply with Professional Standards?
4. Trademark
   Damage Limitations
5. IP Transactions
   It’s Just Not Fair: Unintended and Unforeseen Interpretations of License Agreement Language
6. Continuing Professional Education
   Upcoming Speaking Engagements

Patent

The Value of Financial Analysis in Patent Litigation Settlement Negotiations
by Scott Williams

There are always a number of reasons a plaintiff will pursue patent infringement litigation, and money is certainly near the top of the list. As opposing parties enter settlement negotiations, a great deal of effort is often spent developing validity and infringement arguments. However, it is often the case that less focus is given to preparation of financial arguments despite the fact that financial considerations were often the catalyst for litigation in the first place.

Developing a detailed view of damages early in the case and using this information as a basis for settlement can help drive an earlier settlement. With a detailed financial model, the parties can focus on the components of value and break the impasse that often results from negotiating an overall settlement number. Negotiating settlement numbers can cause parties to become entrenched, especially when those numbers are unsubstantiated. Unsubstantiated settlement offers tend to be overly conservative (i.e., high for plaintiffs and low for defendants), and it’s difficult for the parties to move away from these offers without knowledge of the potential gain or exposure.

Developing an early estimate of damages can also optimize settlement value. It allows a party to negotiate from a position of strength by understanding potential damages from both sides. It is often income-based (revenue generated from accused products) from a plaintiff’s perspective and cost-based (cost of design around) from a defendant’s perspective. An assessment of these values, coupled with a realistic view of infringement and validity can result in better decision-making by both sides.

In addition, early damages estimates can expedite learning within a case. They can bring out opposing counsel’s views of infringement where damages and infringement arguments are intertwined. They can also result in a better understanding of accused product revenue when the accused product is sold as part of a larger assembly or system.

Often, to reduce expenses should the case settle, law firms and their clients forego hiring experts until expert report deadlines are looming. However, a proactive approach may be more prudent. Hiring valuation consultants or damages experts earlier in the process can actually expedite the settlement process while improving the result for the client.

For more information, contact Scott Williams.

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Bankruptcy

The Case for a Liquidation Trust
by Neil Gilmour III

Once upon a time, corporations would file for Chapter 11, reorganize and emerge from bankruptcy. Management and owners would often negotiate a plan of reorganization that provided for cash payments over several years and for the pre-petition shareholders to retain significant, if not their entire, ownership positions. That “once upon a time” was not so long ago. Key to the environment that enabled such reorganizations was that the debt owed to secured lenders was less than the value of the business, leaving equity value for unsecured creditors and shareholders.

Since what seemed like simpler days, the capital markets have developed innovative financing structures, allowing investors, equity sponsors, buyout groups and management to borrow more from lenders through asset-based lending and as part of leveraged transactions such as recaps and acquisitions. Unquestionably, leveraged transactions create a much more efficient capital market that allows shareholders to more easily realize the full value of their investments in cash. On the flip side, the additional leverage that the capital markets provide results in less of an equity cushion to enable the corporation to withstand economic downturns or any of the numerous other negative events that can beset a business. Thus, we see that such highly leveraged companies have been dominating the corporate chapter 11 bankruptcy filings.

The undersecured lenders often adopt an exit strategy that involves the expeditious sale of the business operations through a bankruptcy court approved section 363 sale and utilize the proceeds to partially repay their secured debt. Working together, debtors and lenders often can sell the business operations and distribute the proceeds of the sale to the secured creditors within the first 60 days of the bankruptcy case. This strategy leaves the bankruptcy estate holding the liabilities owed to other creditors and few assets to satisfy those debts. Often the assets are litigation claims that will require aggressive pursuit to create recoveries.

Creditors frequently utilize the liquidation trust resolve structural problems that arise after the Section 363 sale concludes. These problems relate to fundamental issues: unsecured creditors seizing control of the final stages of the bankruptcy, the need for aggressive pursuit of litigation against third parties in which some defendants may be related to the debtor, the importance of the diligent resolution of claim objections and the dissolution of the corporate entity.

Control of the Case
At this point, there are several ways to resolve the bankruptcy filing: dismissal of the case, conversion to chapter 7 or the approval of a plan of liquidation.

The bankruptcy case may be dismissed when, in the aftermath of the sale of the business, there are no assets available for unsecured creditors. The result of a dismissal is that the creditors have all the rights that they had before the filing except that the company no longer has any assets.

Alternatively, the case can be converted from chapter 11 to chapter 7. In this circumstance, a chapter 7 trustee is appointed and both management and the creditors lose control of the bankruptcy. The creditors may have the opportunity to appoint their own trustee, but that rarely occurs.

Rather than deal with either of the above outcomes, unsecured creditors frequently choose to support a plan of liquidation that facilitates the transfer of selected assets, usually cash and third party litigation claims, to a liquidation trust. The unsecured creditors’ committee usually appoints the trustee, selects legal counsel and other professionals and charges them to aggressively pursue the objectives of the committee. Creditor committee members often prefer to select the committee’s professionals to pursue assets on their behalf rather than retaining the debtor’s professionals with whom the committee may have differed on the direction of the bankruptcy.

The committee, or the willing members thereof, may also continue to provide oversight in the form of an advisory committee that will consult with the trustee on key decisions and strategies.

Pursuit of Litigation
The debtor and the unsecured creditors will likely have different targets and litigation objectives. For example, the creditors will scrutinize the actions and inactions of the debtor’s officers and directors to identify possible causes of action. While the debtor may have a difficult time with such actions, the liquidation trust does not hold loyalties to the officers and directors that might inhibit investigations and possible litigation.

The liquidation trust will focus its primary efforts on maximizing the net recovery of claims against third parties. Common litigation includes:

1. Preference action (these actions may be against the very people who selected the trustee).
2. Fraudulent conveyance action against a host of possible defendants such as:
   1. Former owners
   2. Officers and directors
   3. Lenders
3. Litigation against officers and directors for actions covered by D&O insurance policies
4. Accounting and legal malpractice litigation
5. Recoveries of criminal defalcations
6. Claims against investors

In addition to having conflicts regarding officer and director claims, the former management of the liquidated debtor often finds it awkward to be the named plaintiff in actions against their insurance carrier, their suppliers, customers or even their accounting firm. The liquidation trust should have no such qualms.

Resolution of Claims Objections
The unsecured creditors will desire that the claim resolution process be timely and efficient. The debtor has no financial interest in the claim process so assigning that function to the trust will provide the unsecured creditors with the ability to influence the process. The liquidation trust will be responsible for maximizing the distribution to trust beneficiaries in dollars and percentage of allowed claims. The trustee strives to increase the ratio of assets available for distribution (the numerator) over the allowed claims (the denominator). The pursuit of litigation targets the numerator while the claims resolution process focuses on the denominator. As with preference actions, the trust’s opponent in the claims resolution process may be the very parties who selected the trustee. Nevertheless, the objective of the trust is to dispute claims that are not beneficiaries of the trust in accordance with the plan of reorganization so creditors with allowed claims can receive the largest recoveries possible.

The trust also focuses on the cost of pursuing recoveries and resolving claims. Cost management is crucial because the trust’s purpose does not include enriching professionals by pursuing unprofitable litigation. The trust will balance hiring counsel on an hourly versus contingent fee basis for different actions and determine how far to pursue specific actions.

Dissolution of the Corporate Entity
Debtors receive benefits from the creation of a liquidation trust. First, a liquidating debtor can leave many of the responsibilities for post-confirmation case administration to the trust, including resolution of claims, pursuit of preference recoveries, other litigation, processing distribution to creditors, etc. This is particularly important when management becomes unavailable in the aftermath of a sale or business liquidation. Second, in a liquidating case, the trust can continue to fulfill its role and allow the bankrupt corporate entity to be terminated under state law. Finally, in the process of developing the plan of liquidation, the parties can agree to provide releases to selected persons that cannot occur in a dismissal or a chapter 7 conversion.

The adoption of the liquidation trust to deal with the aftermath of a Section 363 sale has developed into an effective solution for the structural problems that the sale leaves behind. Every case is different and the design and responsibilities of the trust will be designed to fit the needs of the parties.

For more information, contact Neil Gilmour.

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Valuation

Must Business Appraisals Comply with Professional Standards?
by Bill Bavis

Talk about standards overload! Many of you have on occasion worked with business appraisers. And, as I am sure you know, there are at least four organizations in the United States that award credentials to business appraisers. Each of these organizations issue standards with which their members must comply. I underline “members” because the standards of each organization presumably only apply to that organization’s members. In other words, if your appraiser is not a member of The National Association of Certified Valuation Analysts (NACVA) he or she need not comply with that organization’s standards. But, what if your appraiser is also a CPA?

In 2007, the American Institute of Certified Public Accountants (AICPA) issued Statement on Standards for Valuation Services No. 1, Valuation of a Business, Business Ownership Interest, Security, or Intangible Asset (SSVS-1). The opening paragraph of SSVS-1 states, in part: “This Statement establishes standards for AICPA members who are engaged to, or, as part of another engagement, estimate the value …”

Not all practicing CPAs are members of the AICPA – joining the AICPA is voluntary, and membership is not a requirement in order to hold a license as a CPA. Accordingly, your appraiser -- or the appraiser hired by the other side in litigation -- may argue that they are not required to comply with SSVS-1 because they are not members of the AICPA.

Does this argument hold water? It may, but most likely it does not. How is that for an answer?

The vast majority of states require CPA licensees to comply with “all applicable professional standards.” This requirement is understood to include generally accepted accounting principles (GAAP), which would include SSVS-1. So, even though your appraiser is not a member of the AICPA, they may still be required to comply with SSVS-1. To protect your own witness or for use in reviewing the work of opposing CPA/appraisers, I recommend that you develop an understanding of SSVS-1 and the appropriate state’s accountancy regulations.

Once you determine whether or not your appraiser is subject to any particular appraisal standards, your job is not over, as evidenced by a recent California divorce case.

During the divorce of a California couple, in re Marriage of Devries, 2009 WL 4264309 (Nov. 30, 2009)(unpublished), a court-appointed forensic accountant valued the husband’s construction business under the excess earnings and capitalization of earnings approach, determining no goodwill value. Using three months of past gross profits, however, the expert came up with a goodwill value of $100,000, which the court adopted in addition to an asset value of $750,000. The husband appealed, claiming that the expert’s use of a three month’s rule of thumb violated paragraph 39 of the AICPA’s valuations standards (SSVS-1), which provides that rules of thumb “… should generally not be used as the only method to estimate the value of the subject interest.”

The California Court of Appeal disagreed. Like many state jurisdictions, the California courts recognize the applicability of the AICPA and other professional standards to valuation issues, but they also have a large body of case law holding that valuation is a flexible determination, based on the various facts and circumstances of each case. “The AICPA guidelines are instructive but not dispositive on the issue,” the court held, relying on prior precedent (the valuation of a medical practice using three months of accounts receivables) to confirm the lower court’s decision.

In most jurisdictions, your CPA/appraiser will be subject to SSVS-1. However, as the Devries case demonstrates, although SSVS-1 guidelines are binding on CPAs, they may not be determinative on valuation issues before the court.

For more information, contact Bill Bavis.

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Trademark

Damage Limitations
by Michele Riley and Marylee Robinson

Most trademark infringement litigation is geared towards obtaining an injunction, but damages are often well worth pursuing. The challenge for rights holders is that the requirements for obtaining an award tend to differ in each federal circuit. In their recent article in The World Trademark Review, Invotex Managing Director Michele Riley and Manager Marylee Robinson discuss groundbreaking trademark damages awards in the most active federal circuits as well as the positions adopted by appellate courts on the prerequisites for damages awards.

Courts generally impose one of two requirements before the plaintiff can recover monetary relief in trademark disputes: actual confusion and/or willfulness. An analysis of these requirements as well as relevant case law yields the conclusion that circuit courts remain divided as to whether a showing of actual willfulness and/or confusion is required to obtain an award of monetary damages. In reviewing trademark litigation activity by circuit, it is clear that certain circuits have more trademark litigation activity than others. Between 2003 and 2008 roughly 55% of all cases filed were filed in the Ninth, Second, and Eleventh Circuits. Cases analyzed in this article include:

• Ninth Circuit: adidas Am., Inc. v. Payless Shoesource, Inc. (546 F. Supp. 2d (D. Or. 2008)) - Jury damage award of $304 million
• Second Circuit: Gucci America Inc v Duty Free Apparel Ltd (315 F Supp 2d (SDNY 2004)) - Maximum statutory damages award of $2 million
• Eleventh Circuit: Nike Inc v Variety Wholesalers Inc (274 F Supp 2d (SD Ga 2003)) - Damage award of $1.3 million

Click here to download the complete article, Damage Limitations, which was originally published in the December/January 2010 issue of The World Trademark Review.

For more information, contact Michele Riley or Marylee Robinson.

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IP Transactions

It’s Just Not Fair: Unintended and Unforeseen Interpretations of License Agreement Language
by Debbie Stewart and Judy Byrd

Eighty-six percent of licensees misreport their royalties to their licensors. In each case of misreporting, a licensor should be exclaiming, "It's not fair!" Register to download Invotex's 2009 annual report on license compliance for statistics from more than a decade of royalty audits as well as common misinterpretations of license agreement language that can cost licensors millions of dollars of royalty revenue every year.

For more information, contact Debbie Stewart or Judy Byrd.

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Upcoming Speaking Engagements

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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.