Intellectual property (“IP”) casts a grey spell on the black and white letters of securities laws and for good reasons. Although there is not a one-size-fits-all approach to this dilemma, this article seeks to blend IP and securities laws: when it should be considered, how it should be examined, and how it should be assessed when making reasonable investments, examining board oversight, or evaluating disclosures associated with intellectual property.
Derivative Actions: Fiduciary Duties of Directors When Managing Intellectual Property
Management of intangible assets such as intellectual property often comprises a high percentage of companies’ assets. For this reason, careful management of IP assets could very well fall within the ambit of directors’ fiduciary duties.[1] Generally, directors of a corporation are required to perform their duties to the corporation with due care, loyalty and in good faith. Due care requires that the directors make information decisions, which therefore requires that they be sufficiently knowledgeable in the subject matter for which such decisions should be made. The duty of loyalty requires that directors take actions in the best interests of the corporation and all director actions must be performed in good faith.[2]
Traditionally, courts have treated intellectual property assets with the same level of due care as any other asset: through the lens of the business judgement rule. The venerable business judgement rule “presumes that ‘in making a business decision the directors of a corporation acted on an informal basis, in good faith, and in the honest belief that the action taken was in the best interests of the company.”[3] When a court invokes the presumptions of the business judgment rule, it assesses director conduct not by looking at the outcome of a given decision, but instead at the process of the board in reaching the decision at issue.[4]
When determining whether to buy or sell material assets, a board will not meet its fiduciary duties unless it is well-informed on the matter. To stay well informed, board members may need to defer to the expertise of intellectual property counsel to glean insights about the IP assets at issue and decide how to proceed with certain business decisions. A plaintiff shareholder may be able to overcome the business judgment rule by showing that the process of arriving at a decision was done in bad faith or on an uninformed basis.[5]
For example, in Miron v. Microsoft Corp, a shareholder brought a derivative action against ContentGuard directors and its majority shareholders who tried to obtain extremely broad and valuable intellectual property licenses from ContentGuard at nominal value.[6] The complaint alleged that the defendants breached their duties of loyalty and good faith and fair dealing by causing ContentGuard to license its valuable IP technology in exchange for only nominal consideration, and that the defendants prevented ContentGuard from growing its revenues, thus acting in bad faith. Ultimately, this case was settled, but it highlights the importance of directors’ knowledge with respect material decisions that affect their company’s IP assets.
Similarly, in Grgurav v. Licul, shareholders brought action directly and derivatively against fellow shareholders and defendant shareholders’ other businesses, alleging infringement and dilution of the corporation’s “Delmonico’s” mark, breach of fiduciary duty, breach of duty of loyalty, conversion, unjust enrichment, deceptive trade practices, and tortious interference with business relationship.[7] Plaintiffs alleged that the use of the “Delmonico’s” mark in connection with Delmonico’s kitchen caused confusion with another nominal defendant’s restaurant.
The Southern District of New York held that the plaintiff shareholders stated a derivative claim on behalf of the corporation for conversion as well as a breach of fiduciary duty claim. First, Grgurav held the directors breached their fiduciary duties against the Co-Owner defendants for intentionally misappropriating one of the defendant’s marks without obtaining authorization of providing compensation for such use.[8] With respect to the trademark, the court also upheld a derivative conversion claim. Typically, only tangible property can be the subject of a conversion action, but intangible rights can form the basis of conversion damages when the converted property is a document into which intangible rights have merged.[9] Similarly, an action for conversion involving intangible property may be sustained when, in reality, it involved the misappropriation of tangible property that manifests intangible intellectual property, such as a master record embodying a musical performance.[10] Moreover, Grgurav dismissed the portion of the plaintiffs’ claims that were premised on misappropriation of the value and goodwill of the trademark and found a trademark has no existence apart from the good will of the product or service it symbolizes. However, the court narrowly upheld the portion of the conversion claim where plaintiffs alleged the exact funds that were misappropriated using the trademark.[11]
Nonetheless, if board members do not have a deep understanding of their corporation’s intellectual property assets, the corporation will likely be subject to derivative claims.[12] When a corporation fails to receive adequate consideration for its material intellectual property assets, shareholders might allege breach of fiduciary claims. These cases also demonstrate that directors should take additional steps to gain additional insight surrounding the materiality of their intellectual property assets so they can adequately align themselves with the business judgment rule.
Securities Violations Surrounding Intellectual Property
The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act” or the “Act”) imposes certain disclosure obligations on public companies.[13] This Act requires that corporations have effective systems in place to monitor and manage their disclosures. For instance, Section 302 of the Sarbanes-Oxley Act requires that the Chief Executive Officer and Chief Financial Officer of a corporation certify the effectiveness of disclosure controls and procedure.[14] Interestingly enough, the Sarbanes-Oxley Act neither explicitly lists intellectual property as something that directors must account for in their disclosure nor imposes any unique requirements for intellectual property issues.[15] However, this is not to say directors should overlook their intellectual property when disclosing material information to investors.
Directors can also face liability for violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. A violation under this section of the Act occurs when a person makes a material misstatement or material omission in the sale or purchase of securities.[16] Material facts are those that may affect the desire of investors to buy, sell, or hold securities.[17] Shareholders and the SEC have both brought claims against directors for their failure to release material information pertaining to their intellectual property assets.
For example, in Sec. and Exch. Comm’n v. Plummer, the SEC filed a complaint against CytoGenix Corporation and two of its board members, claiming the defendants lied to investors by issuing false press releases associated with an influenzas vaccine’s development when the corporation had already lost all its patents in a prior lawsuit.[18] The Southern District of New York found the corporation and its individual defendants liable for such conduct in violation of federal securities laws.[19]
Recently, in Reford v. SolarEdge Technologies, Inc. et al, Lowey Dannenberg filed a securities class action against SolarEdge Technologies, Inc. (“SolarEdge”), SolarEdge Ltd. (a subsidiary of SolarEdge,) and certain individual defendants for failing to disclose that the corporation was under investigation by the United States International Trade Commission (“USITC”) for misappropriating a competitor’s patented technology that comprises a significant portion of SolarEdge’s revenue. The case is Reford v. SolarEdge Technologies, Inc. et al, No. 1:22-cv-09423 (S.D.N.Y. Nov. 3, 2022).
Conclusion
These cases clearly illustrate that directors and board members of corporations need to have a comprehensive understanding of their companies’ intellectual property assets. Failure to give proper consideration for the sale or acquisition of intellectual property rights may result in a derivative action for breach of fiduciary duty claims as well as other claims such as conversion. Additionally, if directors intentionally omit or fail to accurately disclose material information pertaining to their corporation’s intellectual property assets, they could face 10(b) or 10b-5 liability. As intangible assets become more palpable in our corporate climate, shareholders must pay close attention to the duties of directors with respect to these assets and hold them accountable for wrongdoing.
If you have any questions concerning securities law or would like to speak to a securities attorney, please contact Andrea Farah (afarah@lowey.com) or Alesandra Greco (agreco@lowey.com).
[1] Irah H. Donner, Fiduciary Duties of Directors When Managing Intellectual Property, 14 NW. J. Tech & Intell. Prop. 203, 205 (2016).
[2] Id.; Auriga Capital Corp. v. Gatz Props., LLC, 40 A.3d 839, 850–51 (Del. Ch. 2012), aff’d, 59 A.3d 1206 (Del. 2012).
[3] In re Walt Disney Co. Derivative Litig., 906 A.2d 27, 52 (Del. 2006) (quoting Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984)); see also William T. Allen, Jack B. Jacobs & Leo E. Strine, Jr., Function Over Form: A Reassessment of Standards of Review in Delaware Corporation Law, 56 BUS. LAW. 1287, 1298 (2001) (“[A] standard formulation of the business judgment rule in Delaware is that it creates a presumption that (i) a decision was made by directors who (ii) were disinterested and independent, (iii) acted in subjective good faith, and (iv) employed a reasonable decision-making process”).
[4] Paramount Commc’ns, Inc. v. QVC Network, Inc., 637 A.2d 34, 45 n.17 (Del. 1994).
[5] Donner, supra at 206.
[6] See Stockholders Derivative and Class Action Complaint, Miron v. Microsoft Corp., No. 1149, 2005 WL 5769566 (Del. Ch. Mar. 4, 2005), Entry No. 5258185.
[7] Grgurev v. Licul, 229 F. Supp. 3d 267 (S.D.N.Y. 2017).
[8] Id. at 289.
[9] Id. at 287; Ancile Inv. Co. v. Archer Daniels Midland Co., 784 F.Supp.2d 296, 312 (S.D.N.Y. 2011).
[10] Id.; See Sporn v. MCA Records, Inc., 58 N.Y.2d 482 (1983),
[11] Id. at 287.
[12] See also Verified Complaint at 2, Tibotec-Virco CVA v. Rompaey, No. 673-N, 2004 WL 2364795 (Del. Ch. Sept. 1, 2004) (shareholder derivative action alleging Rompaey failed to take reasonable steps when selling intangible assets).
[13] See Sarbanes-Oxley Act, Pub. L. No. 107-204, 116 Stat. 745 (2002) (codified at 15 U.S.C. § 7201).
[14] Id. § 302.
[15] Donner, supra at 213.
[16] 17 C.F.R. § 240.10b-5 (2022).
[17] Castellano v. Young & Rubicam, Inc., 257 F.3d 171, 180 (2d Cir.2001).
[18] Donner, supra at 214; Complaint, Sec. and Exch. Comm’n v. Plummer, No. 14-CV-5441, 2014 WL 3543755 (S.D.N.Y. 2014).
[19] Sec. and Exch. Comm’n v. Plummer, No. 14-CV-5441, 2014 WL 3543755 (S.D.N.Y. 2014), ECF. No. 60.