22 December 2012

‘Please Do Not Offer Equity, As Refusal Often Offends’

Offended“We can’t afford to pay a lot now, but this is going to be really big.  There will be much more work coming in the future…”

No doubt every patent attorney reading this will have heard something along these lines at some point.  Perhaps, indeed, on numerous occasions.  And we know where it is almost always leading: the prospective new client, whom we are meeting for the first time, and about whom we know nothing, is about to ask us to work for a discounted rate, or to provide a fixed quotation (no matter how much of our time they want to take up).  Then at some point they might suggest we take an equity position in their new business, in lieu of a fee.  Or work on a contingency basis, which amounts to the same thing since we would probably want to charge a premium as compensation for the fact that we will only get paid if the business does, in fact, succeed.

Here is a tip if you are a potential client thinking along these lines: we are – to paraphrase Taylor Swift – never, ever, ever going to do it.  Like… ever!

So if you want to save us both the embarrassment of refusal, the polite course is not to bring it up in the first place.

There are many good reasons for this, perhaps the most straightforward being that if we wanted to be in the business of investing in start-up companies, we would probably be working in venture capital.  Patent attorneys provide professional services, i.e. we sell our time and our expertise.  For the most part, patent attorney firms are small-to-medium enterprises (SMEs, just like many of our clients), with around 100 or fewer employees, annual revenue well within the A$20 million used by the Australian Tax Office as the definition of an SME, and for which cash flow is the lifeblood needed to pay the monthly bills (mainly salaries).  If we are not paid for the work we do, when we do it, we will not be in business in that mythical future when the work is flowing, like the Nile in flood, from your successful start-up venture!

But there is another very important reason why a patent attorney might not want to be investing in, or financing, your new business, which is that it is very likely to lead to a conflict of interest that could prevent the attorney from continuing to act for you.  How this can come about – and the fact that it is not merely some hypothetical concern of overly-conservative practitioners – is amply demonstrated by a recent case decided in the Queen’s Bench Division of the England and Wales High Court: Ford & Warren v Warring-Davies [2012] EWHC 3523 (QB) (12 December 2012).

BACKGROUND

Dr Kenneth Warring-Davies is the inventor of heart-monitoring technology, who in 1999 engaged solicitors Ford & Warren to assist him in licensing the invention, on the contingency basis that he would not be charged for the legal services until the invention was successfully licensed, at which point the accumulated fees would become payable in full.

In around 2003/2004 Dr Warring-Davies was close to an agreement with some investors.  However, the proposed deal did not include an up-front payment sufficient to cover the accumulated fees of Ford & Warren, which by then amounted to nearly £250,000.  Dr Warring-Davies therefore needed the solicitors to restructure their contract with him so that the fees would no longer be payable in full immediately upon conclusion of the agreement with the investors.  Ford & Warren declined to do so, and the deal with the investors subsequently collapsed.  The court proceedings arose when Dr Warring-Davies decided that Ford & Warren were responsible for the failure of the licensing deal.

In particular, Dr Warring-Davies contended that Ford & Warren had failed to finalise certain documents required for the deal with the investors to go ahead, despite having been provided with what he regarded as clear instructions to do so.  In failing to act on those instructions, Dr Warring-Davies contended, Ford & Warren had placed its interests ahead of those of its client.

In the end, it mattered little whether there was any merit in Dr Warring-Davies’ complaint, because he commenced legal action more than six years after the alleged breach occurred, and thus outside the period allowed in the UK Limitation Act 1980.  However, the court considered various aspects of the claim, and made it fairly clear that even if the application had not been made out-of-time it most likely would not have been successful.

CONFLICT OF INTEREST ARISES

As with most agreements-gone-sour, at the outset the interests of the parties were aligned, and it must have seemed that the contingency arrangement was a win-win proposition.  Dr Warring-Davies and Ford & Warren both wanted the same thing: a successful licensing deal, such that the invention would be commercialised, and the solicitors would get paid.

Everything no doubt proceeded swimmingly, until the prospect of an actual deal arose.  No longer were there only two parties, with a common goal.  Now there were further parties involved, with the objective of making a realistic investment within their own financial constraints, with an outcome that was also beneficial from their perspective.  The interests of Ford & Warren were no longer aligned with those of their client, if a deal acceptable to the other parties still did not result in the firm being paid for the past four years of services.

As soon as Dr Warring-Davies wanted to renegotiate his agreement with his solicitors, they were clearly in a position of conflict between their own interests and those of their client.  On 5 August 2003, Ford & Warren wrote to Dr Warring-Davies setting out a revised charging proposal in some detail, but made it plain that he should use this letter as the basis to brief an independent law firm.  In other words, Ford & Warren were clearly conscious of the conflict, and properly advised Dr Warring-Davies that he should seek alternative legal advice to assist him in his negotiations with the firm.

JUST BUSINESS?

When, in late 2004, Dr Warring-Davies requested to be told why Ford & Warren had not completed the documents required for the investment deal to go ahead, the firm’s managing partner replied as follows:

This was not a question of Ford & Warren signing off an agreement as if it were some administrative act or some duty on our part. Ford & Warren were being asked by the transacting parties to amend the fees agreement. We did not consent to any alteration of our position and nor did we wish to enter into the proposed transaction. I do not have to explain that, because that is our business decision. It was a matter for you and the other contracting party to address your obligations to Ford & Warren and you have no right to assume - nor demand - that Ford & Warren do something which they were neither legally nor ethically obliged to do. We have no duty whatsoever to enter into a transaction on behalf of ourselves where we do not wish to do so.

Ultimately, one might argue that the ‘business decision’ made by Ford & Warren was a bad one.  The deal subsequently fell apart, and in the end nobody was paid anything.  The offer on the table would have resulted in the solicitors receiving at least a portion of what they were owed.  However, from a business perspective they were perfectly within their rights to hold out for a more favourable opportunity.

CONCLUSION

There are businesses, such as banks, which specialise in lending money to those who need it.  There are others, such as venture capitalists, which specialise in investing money in early-stage businesses in exchange for equity.  What all of these businesses have in common is that they involve evaluating and pricing risk, and building up a portfolio of investments in the hope – if done skilfully – of obtaining some reasonable return by way of profit.

Lawyers and patent attorneys, for the most part, have little or no experience in this area.  And the bulk of our time is occupied in providing the services in which we specialise, not in managing and building a portfolio of investments which, clearly, is a full-time specialist business in itself.

It seems that there was only one person in the whole sorry affair of Ford & Warren v Warring-Davies who was unwilling to take on any risk, and that was Dr Warring-Davies himself.  He bore no risk in using the services of Ford & Warren, because he did not have to pay unless he completed a licensing deal, and he did not have to complete a licensing deal unless it enabled him to pay.  Could he not have obtained £250,000 from some other source, such as a loan or a further investment?  And if not – if the business proposition was not sufficiently sound for funding specialists to take on the risk – what was a firm of solicitors doing carrying the can?

And yet when the whole deal fell apart, Dr Warring-Davies turned belatedly to the courts, trying to pin the blame on the firm that had – rather unwisely – been, for all practical purposes, his first and only investors.  Some gratitude!

So please do not offer us equity, or any other investment ‘opportunity’.  We find that refusal often offends, and harms any prospect of a workable client-attorney relationship from the outset.  There are people who buy equity for a living.  We are not those people.

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