Why Investors Need to Prepare for Disclosure of Diligence Materials in Patent Cases...

Gaston Kroub

Back in January, an interesting lawsuit was filed alleging patent infringement in connection with the burgeoning business of lab-grown diamonds. The seeds for that lawsuit, however, date back to 2018, when M7D, the licensee of the patents at issue, was looking for investment. To that end, M7D hired TM Capital as its agent. As is common in diligence efforts where IP valuation is a key basis for the investment, TM Capital required potential investors to sign a NDA before getting access to confidential material related to the IP. So far, so good.

One potential investor, Huron Capital, signed the NDA — and then hired the prominent law firm Perkins Coie to handle the IP diligence on its behalf. Huron liked what it saw, as it then started working with M7D and TM Capital to attract other investors to M7D’s cause. Each party provided input on a PowerPoint presentation that was prepared — and shown — by TM Capital for potential investors. Again, pretty standard stuff.

Fast forward to the patent case. The defendants asked for a copy of the PowerPoint shown to investors. It was produced, but with three slides redacted. As is common in litigation, however, attempts to prevent certain information from disclosure to an adversary leads to disputes as to whether any such attempts are proper. In M7D’s case, the Hon. Jed S. Rakoff of the Southern District of New York ruled that the redactions were improper, even though the redacted “slides appear to disclose legal conclusions reached by Perkins Coie attorneys” during its diligence work for Huron.

Judge Rakoff’s decision ordering disclosure of the redacted material was based on two key findings. First, he found that at the time Perkins Coie generated the legal advice, Huron was simply a potential investor in M7D’s IP — rendering Huron’s disclosure of its lawyers’ legal advice a waiver of privilege. Put another way, Huron and M7D — at the time of Huron’s disclosure to M7D — did not share a common interest yet. Second, the Court found a second waiver of privilege when the Powerpoint was shown — including the Perkins Coie guidance on the IP — to the other potential investors.

The takeaways for investors and IP owners seeking investment are clear. It is not safe to assume that a common interest exists during the investment procurement stage, especially as it relates to disclosure of privileged information to potential investors. As a result, any presentations containing privileged information made to potential investors — such as on the strength of the IP, or the potential damages at issue in a case — run the risk of being deemed discoverable. While privileged information of that sort could be of major interest to potential investors, it is probably best for everyone to have their own counsel when contemplating an IP investment — both as a check on the work of the lawyers for any counterparty, as well as to possibly create a channel for communication where privilege can be maintained to the extent possible. Because the one thing that is a sure bet is that a sophisticated defendant will pursue broad discovery on any funding arrangements as soon as it gets even a whiff that one was arranged or was contemplated.