Intellectual Property

Trademarks: Trademarks are brand names that enable the public to identify the source of goods or services and distinguish the goods or services of one seller or provider from those of another. A trademark can be a word, name, symbol, graphic or other distinguishing mark, or even a sound or smell, or any combination of these. Examples of trademarks are brand names of products or services.

Copyrights: A copyright is a form of property that grants exclusive rights to the author of a work. The protected work must be fixed in a tangible medium of expression, such as a video, book, computer program or source code, play, painting, photograph, sculpture, architectural drawing, movie, music or television show. Copyright protects an expression of an idea but does not protect the idea alone.

Trade Secrets: A trade secret is any confidential business information that provides an entity, person or company a competitive edge in business. It can be a formula, practice, process, design, instrument, pattern, commercial method or compilation of information which is not generally known or reasonably ascertainable by others, and by which a business can obtain an economic advantage over competitors or customers. A well-known example of a trade secret is the Coca-Cola soda formula.

With the dearth of case law in the matrimonial field, we need methodologies setting forth the best way to value and divide IP assets. How can we determine the value of a piece of art, a script or invention created by a divorcing party, and how can we establish a plan for the future distribution of its value?

Laying the Foundation: Marital Asset Distribution in the Several States

As we know, equitable distribution is the division of assets and obligations acquired during a marriage, whether individually or jointly. Equitable distribution may be effectuated by agreement, or by a judicial decree. And, as with other types of cases, when the courts get involved in distributing marital property, they follow their own states' statutory and case law precedents.

In Connecticut, as a general framework for equitably distributing marital property,
“[t]here are three stages of analysis regarding the equitable distribution of each resource: first, whether the resource is property within the Connecticut General Statutes ' 46b'81 to be equitably distributed (classification); second, what is the appropriate method for determining the value of the property (valuation); and third, what is the most equitable distribution of the property between the parties (distribution).” (Internal quotation marks omitted.)” Cunningham v. Cunningham, 140 Conn. App. 676, 681 (2013) citing Bender v. Bender, 258 Conn. 733 (2001).

In Florida, “the court must begin with the premise that the distribution should be equal, unless there is a justification for an unequal distribution based on a number of relevant factors, such as each party's economic circumstances, contribution to the other's education and time investment in child care, among many others. F.S.A. ' 61.075 (West).

More examples of state law could be offered here, of course, but suffice it to say that in states that follow equitable distribution laws (as opposed to community property states), property acquired during the marriage will be divided between the spouses in a fair and equitable manner; however, there are no set rules for determining who receives what, or what the percentage distribution to each spouse shall be. In the minority of states that apply “community property” laws, when dividing a divorcing couple's assets and obligations, a judge divides the couple's joint assets and debts in half, distributing them between the parties; however, valuation remains an issue. A community property court will not attempt to divide assets based on a framework of factors, as states that follow equitable distribution laws do. (There are only nine community property states; Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.)

Intellectual Property Valuation Methods

Valuation analysts use numerous approaches in order to reach a reasonable indication of a defined value for the subject intangible assets on a certain date. One of the most important aspects in valuing an intellectual property asset is the ability of the asset to generate future income.

The four most common approaches to estimate the fundamental or fair value of the intellectual property are the Cost Approach, Market Approach, Income Approach and Royalty Relief Approach. Federal courts address the issues concerning copyright and patent law, as they are both governed by federal law.

The Cost Approach

The Cost Approach is based on the economic principle of substitution. This principle states that an investor will pay no more for an asset than the cost to obtain, by purchasing or constructing, a substitute asset of equal utility. This approach works best where the asset is not presently producing income or is not expected to produce income and is most commonly used when the intrinsic value of the asset must be reported on the books. There are several cost approach valuation methods, the most common being: 1) the historical cost; 2) the replacement cost; and 3) the replication cost methods.

“Historical Cost” valuation measures the amount of money spent in the development of the intellectual property at the time it was developed. Unless the intellectual property was developed in the recent past, a historic cost measure tends to be unreliable, due to the impact of inflation and the changes that occur in technology over time. In addition, it is not always possible to provide accurate information on the resources spent for such quantification.

“Replication Cost” valuation measures the amount of money that would need to be spent in current cost terms in order to develop the intellectual property in exactly the same way to achieve the same final state in which it currently exists. This includes costs incurred on any unsuccessful or inefficient prototypes. Technological changes and improvements to underlying technology thereafter are disregarded under this method.

“Replacement Cost” valuation calculates the amount of money that would need to be spent in current cost terms in order to develop the intellectual property as it currently exists, but excludes the costs relating to unsuccessful or inefficient prototypes. Technological improvements to underlying technology are taken into account in the calculations under this method.

The Market Approach

The market approach is based on competition and equilibrium. Supply and demand factors will drive the price of an asset at equilibrium point in a free market. Furthermore, it provides an indication of the value by comparing the price at which similar property has exchanged between willing buyers and sellers. Data on such similar transactions may be accessed in several public sources, including specialized royalty rate databases.

For patent evaluation, a market comparables approach should offer a good indication of a patent's value, as it reflects the exchange of value between two parties. However, it is often difficult to find a suitable comparable transaction in valuing patents because of the lack of disclosed sale or licensure activity and the uniqueness of each patent.

The Income Approach

The Income Approach analysis focuses on the economic value of the future cash flow derived from a specific collective property entity, i.e. , the cash flow. This approach estimates the fair value of intellectual property by discounting the future economic benefits of ownership at an appropriate discount rate ' the net present value of the discounted future cash flow. The accuracy in obtaining the discount rate of interest is critical. To determine the value of the future income stream, the following variables are required:

• A projected income stream either from product sales or license of the patent.
• An estimate of the duration of the useful life or its remaining exclusive term of the patent.
• The probability of success if it is not a commercialized product.
• An understanding of risk factors, such as the risk of invalidation, superceding technology or obsolescence and incorporating those into the valuation.
• A real-world, market-appropriate discount rate.
• A determination needs to be made if there are other assets that contribute to the income stream in addition to the intellectual property.

Some of the risk factors in using the Income Approach, especially for patent valuation, include:

New Patent Issuance: New patents can make existing technology obsolete or allow new competitors into the same field. If more competitors are allowed into the same field practicing their own patents, the value of the underlying technology will be diluted. To access the crowdedness in a given technology field requires research in the patent landscape in a particular technological field. It is often difficult to survey the patent landscape because we may not be able to ascertain what patent applications have been filed with the U.S. Patent and Trademark Office. Only issued patents and published patent applications are available for public viewing. Therefore, it is difficult to anticipate what new patent applications are in the field.

Patent Challenges Declared Invalid: After a patent is issued, it still remains vulnerable and open to attack for invalidity. A challenge of invalidity comes in different forms, including for example, claiming that someone other than the named inventor is the “real” inventor to the invention or the invention is “obvious” to persons skilled in the relevant technology. Formal challenges are lodged with the U.S. Patent and Trademark Office. If the challenge is successful, the patent would immediately be rendered as invalid. Any patent licenses will be rendered invalid as well. To protect against this risk, proper due diligence should be performed to anticipate potential problems.

Patent Infringement Suits: Defending a patent infringement suit is costly. It could include treble damages for willful infringement. To protect against such risks, due diligence should be performed prior to evaluation to survey the patent landscape and to anticipate any potential problems.

The Royalty Relief Approach

Relief from royalty is based on deprival value theory and looks at the amount of income that a company would be “deprived” of, if it did not own the intellectual property in question but was required to rent it from a third party instead. The royalty represents the rental charge that would be paid to the licensor if this hypothetical arrangement were in place. The ability to determine an appropriate royalty rate is fact-dependent and requires identifying suitable comparable transactions. A reliable sales forecast is also required for estimating the income stream. There are many online sources that have databases of licensing transactions that can be used to determine an appropriate royalty rate.

This method is useful because the market size and expected market share are generally easy to ascertain. However, the assumption of a rental charge in the evaluation may not readily materialize in reality. We must keep in mind that some patents are of little or no economic value to warrant a rental charge.

Other Approaches

In addition to the four main methods there are others, including the Real Options Method and Venture Capital Method. Using the Real Options Method entails determining certain inputs to the Black Scholes Option pricing model. Such inputs include volatility of cash flows, our estimate of the time horizon and fixed costs invested to commercialize the product. The Venture Capital Method is similar to the discounted cash flow model except that the discount rate is derived in a different manner. Selecting the appropriate method may be based on whether it is an asset in early stages of development (often a cost-approach or optional-pricing model would be used) or it is a mature asset where future forecasts are not so speculative (a discounted cash-flow approach or market approach would be appropriate.)

Regardless of the form of the intellectual property ' such as patent, copyright, trademark or trade secrets ' courts need to divide intellectual property assets according to how the intellectual property can best be monetized and how the intellectual property assets can best be managed. While spouses may argue over the value of the property, courts award rights to the rights-holding spouse and award some portion of the residual or royalty income from the intellectual property to the non'rights-holding spouse. This is because the rights-holding spouse is more likely to know how to further develop the intellectual property portfolio and also to maximize the value of the intellectual property assets.

For example, the inventor can further develop the patent portfolio by continuing to create more inventions in his patented field and to file for more patent applications to build up the patent portfolio. Similarly, for writers who hold copyrights in their novels, screenplays or songs, they are the most familiar with their work and can best monetize or further develop subsequent work based on their rights. In the meanwhile, the non-rights holding spouse can receive his or her interest in the form of income.

Putting the Methods into Use

Some intellectual property assets have been paid out, or are being paid out, and their values are therefore easily determinable and divisible. Other intellectual property assets may not be quantifiable at the time of divorce. A review of some cases shows how courts throughout the United States have addressed the issue of valuing intellectual property in a divorce.

In Teller v. Teller, 99 Haw, 101 (2002), the Supreme Court of Hawaii observed: “Inasmuch as intellectual property has not been the subject of equitable distribution in our courts, we have not developed a method of determining fair market value for such property.” The court there found that the husband's patents and trade secrets were subject to division. As part of the valuation discussion, the “cost approach” was rejected in favor of the “fair market value” methodology.

In Teller, there is an in-depth discussion of the court's analysis, including its reasoning that a trade secret is an “asset” because it has value and its misappropriation is actionable. The complex issues that may arise when an intellectual property asset becomes viable are discussed, such as: If an asset is created before a marriage but the patent is obtained after the date of marriage, the patent is subject to division. Also, the pre-marital aspect of an IP asset may have increased in value during the marriage. These are fact-based analyses to be made. In Telle , the intellectual property had been the subject of an actual sale with a specific value attributed to the IP. As a result, the resolution of the valuation issue was easy for the court, although that is not always the case.

Jacoby v. Jacoby, 134 Haw. 431 (2014), addresses these issues as well. In this case, the IP asset at issue was not sold; the husband was going to receive a stream of income ' i.e., royalties ' from his invention. Once again, the court found that there was a clear basis for determining value.

In McDougal v. McDougal, 451 Mich. 80 (1996), the Michigan Supreme Court affirmed an award relating to an IP asset that provided the recipient spouse with a percentage of the stream of income and not a percentage of the IP asset itself. The high court stated: “The new judgment on remand shall provide that the patents and licensing agreements are the property of the defendant, subject to the defendant's obligation to share the funds generated from those assets, as provided in the new judgment on remand.”

(It is interesting to note that the value of IP has also been addressed in criminal cases concerning the theft of IP assets. For instance, the loss of a trade secret has been calculated as that which a reasonably prudent investor would pay for the trade secret.)

Next month, we propose methods for valuing IP assets, depending on the asset and its position in the life cycle, i.e, it is under development, is currently quantifiable or its value is already being paid out.

Lynne Strober,'a member of this newsletter's Board of Editors,'is chair of the Family Law Department at Mandelbaum Salsburg, P.C. and President of the Barry Croland American Inn of Court.'Jennifer E. Presti'is an associate at the firm and focuses in the areas of family law and commercial litigation.'Elizabeth Lai Featherman'is co-chair of the Intellectual Property practice group at Mandelbaum Salsburg and is a registered patent attorney.'Joan M. D'Uva'is a partner at Eisner Amper, LLP.' She is an accredited business appraiser with the American Society of Appraisers and is a certified public accountant.

'