If you have not managed a company through a downturn, you may not know what to expect in terms of claims and lawsuits. In general, commercial, intellectual property and employment claims all increase in a down market.
The Number of Commercial Claims on Existing Contracts Goes Up
Here is the dynamic for the suppliers of goods in market ups and downs. In a market that is expanding, a supplier of goods is likely to write off a bad account and move on. From its perspective, in an up market it always has additional new customers in its sights, and it makes financial sense to spend its resources chasing those new opportunities rather than bad accounts.
In a down market, where fewer new customers are in sight and existing customers may be putting the brakes on renewals, it makes financial sense to pursue the bad accounts. Accordingly, there is usually an uptick in claims on existing contracts. In addition, where those claims cannot be resolved but there is enough at stake to warrant further action, there is an uptick in mediation, arbitration and new lawsuits.
The current down market differs from the prior two recent down markets (the dot-com bubble bursting and the real estate securities bubble bursting). Instead of being caused by the end of a speculative bubble in a market segment, it is the result of management of a public health risk. That means that legal defenses to payment differ in substance in one respect, which is whether the purchasing entity left itself room to terminate under the current conditions. However, that differential will not meaningfully reduce the number of claims made.
Many of these claims will not trigger insurance. Commercial general liability policies are often written on forms that limit business interruptions to those involving physical damage to a property, and some also include express exclusions for infectious diseases.
Accordingly, unless your company obtained more specialized coverage, the cost of defense is likely to be borne by the companies that receive the claims. Those companies will need to defend them directly rather than tendering them to counsel.
Intellectual Property Claims Are Pursued Against Smaller Competitors
Here is the dynamic for the owners of intellectual property in an up market and in a down market. The owner of intellectual property covering a product that is successful in an up market is likely to compete in the first instance on the merits of the product.
If market entrants emerge that credibly threaten that position, the owner of the intellectual property is likely to assert its intellectual property selectively against those entrants, to protect market share. In an up market, spending executive and engineering time on intellectual property enforcement on other targets usually does not make business sense.
In a down market, a company that has intellectual property that is being infringed may make claims and bring lawsuits against competitors, including smaller competitors, that it would not bring in an up market. Obtaining licensing fees or an award of an obligation to pay a running royalty can help it bridge to the next market expansion.
Alternatively, a company that is closing its doors or is closing a line of business in a down market may elect to sell its intellectual property. The terms of sale could be a one-time fee, or it could be a commitment to provide a percentage of the licensing fees received as a result of enforcement of that intellectual property.
Over the last 20 years, since the dot-com era, an increasingly robust patent market has emerged. Professional patent assertion entities of all sizes have been created and funded. Many more members of the plaintiff's trial bar are engaged in supporting these claims. It is also now easier to find a broker for a substantial portfolio and a network of individual purchasing entities for smaller portfolios.
In addition, since the last downturn, the market of litigation finance has changed substantially. Prior to this market development, rounds of patent assertion were often funded with modest seed capital and by engaging lawyers on contingency fees or mixed-fee arrangements. However, now an assertion campaign with substantial targets can be funded with the assistance of litigation finance that is made available either to the law firm or entity making the patent assertions.
Accordingly, in this downturn, we are already seeing an uptick in claims and can expect to see an uptick in intellectual property lawsuits as a result of this dynamic. In addition, some of the claims will be more difficult to resolve given the involvement of professional enforcement entities and of litigation funding.
Most commercial general liability policies are written on forms that exclude patent infringement. While the market does provide specialized policies for defense against patent infringement, not many companies have that coverage, or the coverage is limited in some material respect. As a result, much of the defense of these claims will fall to the entities that have been sued.
However, where another entity in whole or in part supplied the goods, services or process at issue, depending on the terms the parties negotiated, there may be warranty coverage. The implied warranty of noninfringement may apply, if it has not been excluded during negotiations of the supply agreement.
Surplus Employees Bring Employment Claims
Employment claims also go up in a down market. Two factors are at play that result in more potential claims in a down market. First, you are more likely to be reviewing business lines and may end product offerings or change the focus of your marketing to a different market segment. As a result, you are more likely to be adjusting headcount.
Second, in an up market, a dissatisfied employee can more readily move to a new employer. In a down market, you will retain the dissatisfied team members for longer, and if their dissatisfaction impacts their job performance, you are more likely to end up terminating them.
These surplus employees are more likely to bring actual claims in a down market, if the market has not provided other adequate alternative employment.
Some of these claims are covered by your employer's liability policy. However, many are not, given the significant policy exclusions found in these policies.
This confluence of events that leads to an increase in claims can make successfully managing a business through a downturn yet more challenging than anticipated. It's important to remember that an increase in claims at a specific company or in a specific business unit is likely the result of these market trends and is not a reflection on the leadership of that business.
Originally published June 30, 2020, by Law360.