Litigation as a negotation strategy November 7, 2007

Andrew Bridges of Winston Strawn recently spoke to a number of Lightspeed‘s portfolio companies about how to best manage IP, copyright and trademark risks. Andrew is a highly regarded litigator who has been the lead counsel in a variety of notable intellectual property cases, including involvement with the Morpheus, Napster, Grokster, ReplayTV, Rio MP3 player and Clearplay cases. Afterwards, I email interviewed him about how some big media companies use litigation as a negotiation tactic.

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Jeremy: Great seeing you this week Andrew. I heard great feedback from a number of portfolio companies on your presentations about copyright and trademark law, especially from the social media and user generated content folks. I was really interested in your comments about difference in mindsets between Hollywood and the Valley, and how some big media companies are using litigation as part of their arsenal of negotiation tactics. Viacom’s suit against Youtube of course comes to mind, as well as Universal’s against Veoh. What are some other high profile example that you can think of, and to what extent do you think they are a genuine attempt to get injunctive relief and stop a technology company from doing what it does, versus simply increasing the pressure for a negotiation?

Andrew: I think one recent example of this was Warner Music Group’s lawsuit against Imeem. WMG sued Imeem although the two companies had been negotiating an agreement for a while, and even after Imeem had announced its impending implementation of a filtering solution from SNOCAP. There’s a famous saying of von Clausewitz: “War is the continuation of diplomacy by other means.” Translate “war” to “litigation,” and “diplomacy” to “negotiation,” and the phrase describes some Hollywood attitudes.

One common strategy by media companies is to send woefully deficient DMCA notices, or not send any notices at all, and then sue a company for hosting or pointing to allegedly infringing materials. The copyright holders claim that the notices are unnecessary because the defendants blew the DMCA safe harbor, yet they don’t take advantage of easy tools for limiting infringement. Seems suspicious, don’t you think? Their actions suggest that they are not just looking to eliminate infringement, but for something else. Sometimes they are looking for immediate negotiation advantage to press to a quick conclusion. At other times they are designed to set up catastrophic damage claims so that they can secure favorable revenue shares, equity stakes, and so forth.

There are several of those cases pending right now.

Jeremy: Interesting. So in a sense it’s a privilege to be sued since it indicates that the media company thinks you’ll be the winner and want to push to a quick and profitable agreement with you? Would you say that some companies are more aggressive than others using this tactic?

Andrew: Being sued sucks. People who welcome it for the publicity change their minds very quickly once they discover all the disadvantages. But I do think that there is a parallel between being a litigation target and being deal-worthy. Hollywood is hit-driven both in its content and in its deal making. Labels and studios don’t want to waste time doing deals with insignificant companies, and they aren’t likely to sue companies they consider insignificant. When a company gets enough traction, it will attract the attention of both the dealmakers and the litigators at about the same time. For that reason, companies with disruptive business models who want to do deals with Hollywood need to accept a certain amount of litigation risk.

Universal Music Group is a very aggressive litigator. Look at the lawsuits brought by both Veoh and Divx against UMG. The suits are for “declaratory judgments”. Typically, it’s only companies that have been threatened with litigation that bring that kind of lawsuit. They are seeking declarations of non-liability, to clear the air without waiting for the threatening party to sue. The Supreme Court has made it easier for threatened companies to bring this kind of lawsuit. The availability of declaratory judgments curtails the ability of companies to make heavy-handed threats, intended to paralyze young companies and their investors, without ever actually following through and putting their claims to the test.

Jeremy: So at what point does it make sense for a startup to consider seeking a declaratory judgment? Is winning a declaratory judgment a “hall pass” that protects you against being sued by any similar company, or just the company that you’re suing? Both Voeh and Divx are well funded (in Divx’s case public) companies with very meaningful user bases. Does it only make sense for companies at that stage? And what are the costs of seeking a declaratory judgment through litigation?

Andrew: A declaratory judgment only protects you against the company you sued. However, it may cause other companies to take notice and temper their activities. Generally speaking, a startup should file a suit for a declaratory judgment only when (a) you’re certain you’re going to be sued and you want to choose the location of the suit by filing first, or (b) you can’t stand the paralyzing effect of a threat that won’t go away any longer and want to get the issue resolved sooner rather than later.

All this sort of litigation expensive, with costs over the full course of a case usually in the millions. Sometimes it is the burn rate, rather than the total cost, that is the important factor. For instance, Napster faced a preliminary injunction to shut the company down before trial. The fight to stop that was fierce and costly. When I was defending StreamCast (Morpheus) in the Grokster case, we filed a very early summary judgment motion to preempt the other side’s ability to seek a preliminary injunction. That worked to our favor. But the judge in that case then set the case on an impossibly fast schedule that required a brutal burn rate. Litigation is very much like war. Think about the failed predictions in Iraq. It’s an instructive exercise.

Jeremy: It doesn’t seem like there are any easy choices here. It seems like there are plenty of examples of startups that didn’t play this right and ended up going out of business. Are there any examples of startups that you would point to as people who played it right? Ideally folks that have seen an outcome, rather than stuff that is still in flight.

Andrew: The biggest and best examples weren’t startups: they were Sony in its introduction of the Betamax, Apple in its introduction of on-board CD burners (remember Rip. Mix. Burn.?), and Diamond Multimedia in its introduction of the Rio MP3 player. They faced down either litigation or some pretty heavy threats. Google has gone from startup to giant before our eyes, and it has carried litigation risk throughout, while being careful to articulate its legal justifications and enormous societal benefits for its technologies and business models. I think Google has to be counted as a major success whatever happens with its various pending cases. Among the very new companies I think Imeem has shown that it can be eager for deals while being prepared to defend itself vigorously if attacked. The recent declaratory relief cases by Veoh and Divx may show that a tide has turned — but only time will tell.