5 April 2004
Typically, lawyers perceive their role as being reactive. They work to solve the problems of their clients when things go wrong or arise unexpectedly. Yet companies would benefit tremendously from the guidance and experience of their legal advisers when planning their risk management strategies, to prevent or minimise losses arising from intangible assets. This need not mean less billing for the profession – rather new opportunities and a healthier reputation for all.
However, it is not just companies’ external advisers that are to blame. Many companies, both large and small and from a range of industries, are only now waking up to the realisation that between 65 per cent and 80 per cent of the value of business today is tied up in intangible assets, rather than physical plant, property, machinery and stock. Unfortunately, the associated threats will only increase as image and reputation take centre stage.
Understanding intangible asset risks
The 700 global companies that spend most on research and development (R&D) have an annual expenditure of more than $200bn (£110.11bn). Despite economic uncertainties around the world, this figure continues to rise year on year. This considerable input for the company bears fruition in the form of ‘goodwill’ and intellectual property (IP) as brand, reputation and intellectual property rights (IPR) become key differentiators in the global business community.
While chief executive officers, finance directors and risk managers are becoming increasingly aware that major incidents can go much further than the initial cost of physical loss, it is taking time for businesses to quantify their exposure and attitudes. At present, only 22 per cent of companies are likely to have developed risk management strategies to protect the massive investment in and assets of brand and reputation. It takes considerable effort and coordination to analyse brand and IP exposures that, by their nature, require the understanding and buy-in of numerous component divisions. A strategy must be implemented and coordinated from board level, yet it must also retain the advice of marketers, risk managers, accountants and lawyers.
No entity can trade without its reputation, and increasingly, no entity can trade without its IP. The loss of goodwill through business practice or catastrophe can have disastrous consequences.
Companies that are particularly vulnerable to financial damage through intangible assets include online businesses, consultancies, charities and purveyors of high street brands. In the service sector, the demise of auditor Andersen demonstrates what can happen to a company when customers lose confidence in it. For customers, the brand name, ethics and reputation of a company can be crucial in the purchasing decision of a given product or service.
Take the IPR from a pharmaceutical, automobile, electronic or electrical company, such as patents and trademarks, and imagine the consequences. Pharmaceutical giant Merck, for example, warned that its 2002 profits would be affected by the patent expiry of Prilosec, the world’s best-selling prescription drug at the time. The announcement led to a 9 per cent fall on the New York stock exchange in one day. This is not unusual, and, in fact, losses of IP rights can have a more far-reaching effect than a dip in revenue – the entire strategy of the company is affected and it will be lucky to come away from the experience unscathed. Many businesses do not survive to tell the tale, especially those university spin-outs or think-tank start-ups that own nothing but the shirt on their back and a clutch of patent certificates they cannot afford to protect.
Knowing what help is at hand – insurance
Changes in perception, along with the indirect pressures of corporate governance, and changes to accounting standards and the current financial and political climate, have begun to focus minds on the challenges of intangible assets. No longer is it responsible to treat the intangibles as a by-product of a company’s goals or simply a business risk associated with the prospect of success or failure of a product. When there are threats to the major revenue-generating assets of a company the need for proactive measures is clear. The challenges of identifying, quantifying and protecting intangible assets are paramount.
Having identified the possible risks, it is worth considering whether the potential losses can be cost-effectively absorbed within the organisation or whether some form of risk transfer is more appropriate.
Most clients and lawyers are aware of IP insurance, but they are often only familiar with it at its most base level – the reactive model. The typical cover provides for legal expenses in the pursuit or defence of an IP dispute, and may also insure the company for any legal liability it incurs and resulting damages awards. These insurance policies have their place and every IP lawyer should be aware of them and where to get them for the sake of their client. They are, of course, particularly valuable to the small to medium-sized client – the client who will be hurt by the average $2m (£1.1m) legal fee or a multiple of this in damages awards from the US. They are also invaluable to the ‘client of straw’ – the client that has great ideas but an absence of cash. The fighting fund will ensure that they can defend their IPR from unscrupulous larger corporations, or indeed take action upon those that feel big enough to serially infringe.
However, lawyers might feel reluctant to point their client in the direction of reputation insurance. There has been extremely limited success in this field and it has, in the most part, rested upon the provision of public relations consultants in the case of a loss event – not always the optimal form of cover for the client.
Despite talk that the insurance industry has not faced up to the challenge of providing enough coverage for the field of intangibles, innovative products have been and are being created in the Lloyd’s of London market. These products specifically protect businesses against the financial fallout from damage done to corporate reputation and IPR.
During the past two or three years, the London market has seen an influx of capital, mostly focusing on low-risk, high-earning business that has a short or limited period of liability and is not overly specialised. However, capacity to write a wider range of liabilities is increasing as capital is moved from less-profitable classes. As a result, and with the expected downturn in property/casualty premiums in coming years, insurers are increasingly interested in more specialised lines of cover, such as those that provide balance sheet protection if the intangible assets of a company are lost or damaged.
Two products that have emerged in recent years have revolutionised the insurance of intangible assets: one product for IPR and one for reputation. The key to their success is their first-party nature. The company is covered against the financial impact it feels following a loss event and not its liabilities. Quite often there are no legal liabilities following a loss event, or the impact upon the owner of the IPR or reputation is far in excess of these liabilities. Working on models of expected income, profit, R&D expended or financial investment, the client can be insured for the financial deviation it might suffer from its expected earnings in the coming years.
The insured events causing such loss could be legal claims made against the company’s IPR by another company or employee, governmental actions preventing exploitation of IPR, or adverse media reports. Such insurance requires sound underwriting and relationships between lawyers and accountants for accurate independent audits and reports. The resulting policy often offers considerable peace of mind and enables more efficient investment opportunities.
Companies and the counsel they keep must be aware of the developments being made in the field of intangible assets. Knowing all the risks and covering against them is beneficial to all parties as businesses compete in the increasingly competitive and ever-changing global marketplace.
Matthew Hogg is a technical underwriter and IP specialist at Lloyd’s insurer Kiln