Insights by Bierce & Kenerson, P.C. Editor. www.biercekenerson.com.

Vol. 13,  No. 2, March/April  2013

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FEEDBACK: Since 2001, Outsourcing Law & Business Journal™ has been addressing legal issues in operational excellence in business services through effective sourcing practices and service integration for global and globalizing enterprises.  Covered operations include business services in IT, HR, finance and accounting, procurement, logistics, manufacturing and customer relationship management. Send us your suggestions for article topics, or report a broken link at wbierce@biercekenerson.com. The information provided herein does not necessarily constitute the opinion of Bierce & Kenerson, P.C. or any author or its clients. This newsletter is not legal advice and does not create an attorney-client relationship. Reproductions must include our copyright notice. For reprint permission, please contact: wbierce@biercekenerson.com. Edited by Bierce & Kenerson, P.C. Copyright (c) 2013, Outsourcing Law Global, LLC. All rights reserved. Editor-in-Chief: William Bierce of Bierce & Kenerson, P.C., located at 420 Lexington Avenue, Suite 2920, New York, NY 10170, 212-840-0080.

On April 16, 2013, Senator Chuck Schumer (D., N.Y), introduced a bill, S. 744, Border Security, Economic Opportunity, and Immigration Modernization Act, which proposes significant changes to current immigration laws.   Title IV of this draft targets nonimmigrant visa programs and impacts directly on any company “dependent” on foreign labor, generally defined as any company with 15% or more of its full-time employees classified as H1-B nonimmigran  workers.  If enacted, these reforms would drastically change the landscape, altering the economic incentives, imposing new limits on offshore outsourcers, promoting local American workers and creating new bureaucratic compliance rules affecting all employers with any H1-B worker.

The Future of Outsourcing

Global Restructuring of Global Services.   If enacted, the bill portends some potential major changes in the way companies and their foreign service providers do business.   We can anticipate the following possibilities:

• Foreign Labor at a Higher Cost.  Companies could continue to use substantial foreign tech labor as consultants in the U.S., but only after paying substantially higher filing fees for visa applications.  For example, in the years 2015-2017, applicants that employ 50 or more employees in the United States with more than 50 percent and less than 75 percent of its employees classified as H-1B or L nonimmigrants will have to pay $10,000 per visa.
• Acquisitions and Mergers.   To play with ratios, outsourcers will likely acquire U.S. business service providers with large workforces (for about 850,000 U.S. workers in the aggregate).  This might circumvent the new visa barriers but would likely dilute overall ROI by incorporating lower-profitability businesses.
• More U.S. Employment; More Offshoring.  In principle, offshore outsourcers would hire more U.S. citizens and lawful permanent residents (LPR’s), assuming their skills fit the demand.  In practice, more tech jobs might move offshore, either by outsourcing or by “shared services” “centers of excellence.”
• Centers of Excellence: More Offshoring.  The reform legislation could backfire, creating incentives for more foreign “centers of excellence” owned and operated by global enterprises as “shared service centers.”  To absorb volatility in demand, multinationals could augment the staff of their offshore COE’s with project support from foreign outsourcers.  Thus, reforms might cause unintended consequences that promote even more offshoring and even less local U.S. employment.

These reforms could offer new opportunities for business process transformation, global workforce planning, access to new markets and greater integration of global service delivery centers (across multiple countries) with customer service and account management in the U.S.

The Details of Immigration Reform affecting H1-B Visas

Increased H1- B Quotas.  America employers would have greater access to foreign workers directly because the numerical cap would rise from 65,000 to between 110,000 and 180,000 new H-1B visas per year, depending on a High Skilled Jobs Demand Index, but the new cap could not fluctuate by more than 10,000 from the prior year’s cap.  The exemption cap on foreign advance degree graduates of U.S. universities would increase from 20,000  to 25,000  if they fit within STEM categories: computer and information sciences and support services, engineering, mathematics and statistics, and physical sciences.  Employers would pay a new supplemental application fee of $500 for labor certification applications, to be used for STEM Education and Training and primarily for scholarships for low-income U.S. students enrolled in STEM studies and for K-12 STEM education.

Equal Conditions of H1-B Employment. The draft law would effectively create an “equal opportunity act” for H1-B foreigners.   It would require that U.S. employers treat foreign H-1B workers as equals in pay, benefits, incentive compensation and “at will” termination of employment by the worker.   It would be a violation of the new law for an H-1B employer to fail to offer to an H-1B nonimmigrant, during the term of authorized employment, “on the same basis, and in accordance with the same criteria, as the employer offers to similarly situated United States workers, benefits and eligibility for benefits.”   Specifically, the employer would violate immigration laws by discriminating against the H-1B workers in (i)  the opportunity to participate in health, life, disability, and other insurance plans; (ii) the opportunity to participate in retirement and savings plans; or (iii) cash bonuses and noncash compensation, such as stock options (whether or not based on performance).”   The employer would thus have to treat H-1B employees as full-time equivalents for purposes of coverage under ObamaCare (the Patient Protection and Affordable Care Act of 2010).

Reciprocity for the H1-B Worker’s Spouse.   The proposal would authorize a work permit for a H-1B worker’s spouse, but only under reciprocity.  If the H1-B’s foreign country permits similarly situated U.S. spouses of U.S. workers to have work permits, the U.S. would do the same.

Protections against Displacement.   Displacement of American workers would be mitigated by several key mechanisms:

Quotas.  The bill would limit a company’s percentage of H-1B employees to 75% in 2015, 65% in 2016 and 50% after 2015 (“intending immigrants” not counted in this number).

Wage Levels.  The wage levels would need to be competitive.   The H-1B worker’s wages for a dependent employer would need to be set at not less than Level 2 wages or the mean of all surveyed wages for the specific occupational classification (geographically located), as provided by the U.S. Secretary of Labor.   The employer would need to advertise on the searchable Internet website maintained by the U.S. Secretary of Labor, for at least 30 calendar days, a detailed description of each position for which a nonimmigrant is sought that includes a description of (i) the wage ranges and other terms and conditions of employment; (ii) the minimum education, training, experience, and other requirements for the position; and (iii) the process for applying for the position.

Timeframes Preventing Displacement.  A non-dependent H-1B U.S. employer would need to show that it did not displace and will not displace a United States worker employed by the employer within the period beginning 90 days before and ending 90 days after the date of filing of any visa petition supported by the application.  For H-1B dependent employers and employers that committed a “willful failure or misrepresentation” in the five years preceding the application, the period would be 180 days before and after the filing of the visa petition.

Staff Leasing.   “Staff augmentation” outplacement would be prohibited for H-1B dependent employers, who could not “place, outsource, lease, or otherwise contract for the services or placement of an H-1B nonimmigrant employee”.  For other employers, the prohibition would apply unless the employer pays a fee of $500.

Advertising.  Employers would be prohibited from advertising that the particular job opening is “only available” to an H-1B foreigner or an F-1 foreigner (optional practical training after education in the U.S.).

In addition, outplacement of L-1 visa workers would be prohibited, closing the channel for intracompany transfers of L-1s.

Conclusions

The draft reforms would change the face of the American economy for business services.  Specialized service companies with fewer than 50 U.S. full-time employees and hundreds of offshore workers in foreign service centers could gain competitive cost advantages by beating the costs of both ObamaCare and the new immigration restrictions.

When combined with changes in funding for startups under the JOBS Act of 2011, the proposed “Border Security, Economic Opportunity, and Immigration Modernization Act” will provide a boost to North American outsourcers such as Accenture, CGI, CSC, Hewlett-Packard, IBM and Xerox.  It will also require adjustments in business models for offshore-centric service providers.   As with any change, opportunities and threats will emerge as the details are worked out in the legislative process.

Insights by Bierce & Kenerson, P.C. Editor. www.biercekenerson.com.

Vol. 13,  No. 2, February,  2013

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FEEDBACK: Since 2001, Outsourcing Law & Business Journal™ has been addressing legal issues in operational excellence in business services through effective sourcing practices and service integration for global and globalizing enterprises.  Covered operations include business services in IT, HR, finance and accounting, procurement, logistics, manufacturing and customer relationship management. Send us your suggestions for article topics, or report a broken link at wbierce@biercekenerson.com. The information provided herein does not necessarily constitute the opinion of Bierce & Kenerson, P.C. or any author or its clients. This newsletter is not legal advice and does not create an attorney-client relationship. Reproductions must include our copyright notice. For reprint permission, please contact: wbierce@biercekenerson.com. Edited by Bierce & Kenerson, P.C. Copyright (c) 2013, Outsourcing Law Global, LLC. All rights reserved. Editor-in-Chief: William Bierce of Bierce & Kenerson, P.C., located at 420 Lexington Avenue, Suite 2920, New York, NY 10170, 212-840-0080.

A January 25, 2013 decision of the Delaware Chancery Court decided that a 50% owner of a Delaware LLC was responsible for misappropriation (or “usurpation”) of corporate opportunities of the LLC by entering into business operations that competed with the LLC’s core purpose of business.   The court awarded $3.08 million in damages from usurpation.
For new venture startups, friends and family investors, angel investors, venture capital investors as well as mid-sized businesses seeking growth, it is critical from the start to ensure that the new venture is designed well and implemented by all parties.  The lessons apply to pre-nuptial agreements for strategic business relationships ranging from co-investment to supply chain and value chain relationships.

The New Venture.   In 2006, a U.S. former senior executive of a national cable telecom company (the “Entrepreneur”) and a U.K. technology company (the “Platform Company”) formed a 50-50 Delaware LLC to exploit “interactive video and advertising” activities in North America.  The Entrepreneur agreed to, and did, provide access to his broad industry contacts.   The Platform Company, a United Kingdom business that owned proprietary mobile marketing technologies, would provide technical resources, and its 50% ownership would be held by a subsidiary.

Exclusivity of LLC’s Business Purpose.  The Delaware LLC’s operating agreement contained an exclusive-dealing clause that stated that interactive video and advertising activities in North America by either joint venturer or their affiliates would take place exclusively through the joint venture.  It excluded the UK company’s (and its subsidiaries‘) “North American non-video based mobile and on-line marketing businesses.”  It expressly permitted the members and their subsidiaries to “engage in any business activities except those whose primary purpose involve the enabling and enhancing of interactive video programming and advertising content across multiple digital platforms.”  In re: MobileActive Media, LLC, a Delaware LLC, Del. Chancery No. 5725-VCP (Jan.25, 2013), slip op.  [Citations omitted]

Prospects for Success.  The joint venture had bright prospects due to introductions provided by the Entrepreneur to executives in the telecommunications and advertising industries.   These led to two business deals, but further growth was stunted due to a conflict of interest and lack of support from the UK Platform Company.

Struggles between the Members.  Shortly after the operating agreement was signed, the UK Platform Company offered to buy out the Entrepreneur’s 50% interest.   They realized it was a bad deal early, but did not resolve their differences.  They ignored the disagreement without terminating the joint venture and made several acquisitions in related technologies.  Over a period that started a few months after the signing of the LLC operating agreement for MobileActive, the UK Platform Company (and its subsidiaries) closed on acquisitions of companies that owned:

(1)    an off-the-shelf SMS gateway and reporting package;
(2)    a micropayments business that allowed users to send and receive a text message to authorize the purchase of virtual goods;
(3)    a Toronto based advertising and marketing boutique that provided traditional types of marketing services;
(4)    a Canadian analytics business that provided database solutions and predictive analytics; and
(5)    a Canadian analytic search technologies company with technologies that allowed non-technical users ―to query very, very large databases and create customized reports in a very rapid fashion; and
(6)    a Delaware corporation that had a sizeable SMS network of 17 million consumers and the technology to deliver advertising to the network.

The UK company never offered any opportunity to the Delaware LLC or the Entrepreneur to invest in such target companies.

Eventually, the subsidiary of the UK Platform Company that was the 50% member went through a restructuring and transferred all of its assets to a newly formed Canadian company for less than fair value.  The Entrepreneur successfully disputed the value of the consideration the company paid in this transaction, claiming  it violated the Delaware Uniform Fraudulent Transfer Act. The new Canadian company was then sold in 2011 for approximately $100 million. The Entrepreneur did not receive a cent from these transactions and chose to sue, claiming breach of fiduciary duty.  The Court awarded him 3.08 million dollars and impressed a trust on the assets.

Elements of a Claim for Breach of Fiduciary Duty by Misappropriation of Corporate Opportunity.  As a general reminder to all considering a new business venture, under Delaware corporate law (as recounted by Vice Chancellor Parsons):

“A claim for breach of fiduciary duty requires proof of two elements: (1) that a fiduciary duty existed and (2) that the defendant breached that duty. ―At the core of the fiduciary duty is the notion of loyalty—the equitable requirement that, with respect to the property subject to the duty, a fiduciary always must act in a good faith effort to advance the interests of his beneficiary. ―It forbids one joint adventurer from acquiring solely for himself any profit or secret advantage in connection with the common enterprise. ―The doctrine of corporate opportunity represents but one species of the broad fiduciary duties. The elements of misappropriation of corporate opportunity are: (1) the opportunity is within the corporation‘s line of business; (2) the corporation has an interest or expectancy in the opportunity; (3) the corporation is financially able to exploit the opportunity; and (4) by taking the opportunity for his own, the corporate fiduciary is placed in a position inimical to his duties to the corporation.”   Id.

Lessons for New Ventures (especially Tech Ventures and IT-Enabled Business Process Management Ventures).    This case highlights classic truths of business law.

• Clear Definition of Corporate Purpose.   Every equity owner of a company should agree on the shared scope of business. The definition should serve as a clear guide for future conduct to avoid possible breaches of the fiduciary duty of loyalty.</li>

• Get All Parties to Approve.  The senior management of all equity owners should exercise their business judgment and commit to the new venture’s scope.  What the Delaware court failed to mention was that the board of directors and officers of the UK Platform Company are liable to the shareholders under UK fiduciary duty principles because they knew, or should have known, of the conflicts with the US Entrepreneur and sought to circumvent his rights anyway.

• Relationship Management.   The US Entrepreneur was partially at fault for not getting all of the UK Platform Company’s management “on board” and fully committed.   He also failed to manage the relationship through a specific management procedure under the Operating Agreement to ensure full disclosure and early resolution of conflicts.

• Valuation.  The litigation occurred because the parties disagreed on the value of what was created and what was eventually to be divided among the owners.  The $3.08 million damage award shows that disloyal conduct can be expensive.  Both parties should consider use of appraisals or other methods for valuation when a dispute becomes irreconcilable.

• Dispute Resolution Process and Exit Plan.  A well-drafted Operating Agreement will identify the method for resolving disputes.  Under Delaware LLC law, liquidation and dissolution is the only solution permitted, unless the parties have agreed otherwise.  Investors and other passive owners should be particularly concerned about the risk of dissolution, so they may wish to provide for some form of “work out” involving ongoing operations to be managed by an interim manager while a buyer is sought to buy the entire business.

• Legal Fees.  Legal fees for enforcement of contract rights under an LLC’s Operating Agreement are not recoverable as damages, unless the contract requires it or unless statutes allow such recovery.  The weaker party should consider the impact of such a clause.

• Fiduciary Duty.  Some LLC’s may be managed by members (or managers) who have no fiduciary duty to the members.  Depending on the applicable law, such exculpatory provisions could have a serious impact on the future of the enterprise and enable one member to take unfair advantage of the others.  The equity owners who are not managers should consider the impact of such an exculpatory clause.

Burdening Both Small and Larger Businesses):  Bye-Bye, Back Office Employees; Hello, New Small Service Providers.   The Patient Protection and Affordable Care Act of 2010 is pushing small business owners to cut back on full-time employee staffing.    The law is over 1,000 pages long.  Among its key provisions is a mandate for individuals to get medical insurance (or pay a tax of $2,000).  Another key mandate requires U.S. employers with over 50 full-time employees to pay for coverage for their employees, effective January 1, 2014.  (Incidentally, as of March 1, 2013, U.S. employers must now disclose to their employees in writing whether the employer has obtained medical insurance for the employee.)

Under these conditions, outsourcing will grow because the back office (finance, accounting, human resources administration) does not generate revenue and thus cannot be leveraged for purposes of valuation.  We predict a boomlet of new small service providers offering such services, with the real work being done in foreign countries under the supervision of U.S. founders.  For a well-designed new service provider, startup costs are modest and return on investment can be recovered within six to twelve months by leveraging a scalable offshore service delivery center.

Even if such outsourcing is not so robust, small business owners will seek to enter into new “independent contractor” agreements with current back office employees to kick them off the payroll and keep the business size at below 50 FTE’s.

Favoring Foreign Manufacturers and Service Providers:  New Tax on U.S. Energy Consumption, No Tax on Products of Foreign Energy Consumption.   President Obama wants a carbon tax on energy consumption.  A draft law failed in 2010.   Now, if Congress does not act, he will administratively issue regulations to “reduce pollution, prepare our communities for the consequences of climate change, and speed the transition to more sustainable sources of energy.”

If such a carbon tax is enacted, it will apply only to U.S. producers of energy and other greenhouse gas (GHG) emissions.   The tax would not apply to foreign energy producers or foreign GHG emissions.  The tax would not be applied to the importation of finished products from countries that have not such tax.   So such a tax would increase the cost of U.S.-made products (and energy consuming services such as office workers) and also promote the importation of foreign-made goods and foreign services that are not so taxed.

Promoting Foreign Jobs along with American Jobs: Upgraded U.S. Energy Production Infrastructure.   President Obama approves the hiring of U.S. workers by foreign companies in the U.S.  “The CEO of Siemens America — a company that brought hundreds of new jobs to North Carolina — said that if we upgrade our infrastructure, they’ll bring even more jobs.  And that’s the attitude of a lot of companies all around the world.  And I know you want these job-creating projects in your district.”   It’s not clear where the R&D work or manufacturing will take place for energy projects, but the U.S. does have some obligations under WTO agreements to treat certain foreign manufacturers equally.

Comparative Advantage for Automation:  Higher Minimum Wages, Maybe More Automation.  “Tonight, let’s declare that in the wealthiest nation on Earth, no one who works full-time should have to live in poverty, and raise the federal minimum wage to $9.00 an hour.”   By increasing the cost of labor, this could promote capital investment in machines and software that could replace labor.

Cybersecurity: Sharing of Private Data with U.S. Government.  In his speech, President Obama viewed cybersecurity of critical infrastructures as essential to national security.  “And that’s why, earlier today, I signed a new executive order that will strengthen our cyber defenses by increasing information sharing, and developing standards to protect our national security, our jobs, and our privacy.”

His Feb. 12, 2013 Executive Order to Improve National Cybersecurity will establish a “voluntary information sharing program” that will “provide classified cyber threat and technical information from the Government to eligible critical infrastructure companies or commercial service providers that offer security services to critical infrastructure.”   Under this Executive Order, the term critical infrastructure means “systems and assets, whether physical or virtual, so vital to the United States that the incapacity or destruction of such systems and assets would have a debilitating impact on security, national economic security, national public health or safety, or any combination of those matters.”

The regulations implementing this “voluntary” program have not been drafted.  A draft law on the same subject failed in 2012 because “voluntary” sharing did not come with insulation from liability to third-party stakeholders such as customers, individuals, patients, suppliers and others.

We can speculate whether the eventual regulations will promote offshoring of data centers or more virtualization of data services.   It could have the opposite effect, of forcing full supply-chain cybersecurity across national borders.  It could result in more segregation of data collected overseas and hiving off of such data so that it is not processed in the U.S. in order to avoid potential liability from complying with the new regulations.

Insights by Bierce & Kenerson, P.C. Editor. www.biercekenerson.com.

Vol. 13,  No. 1, January,  2013

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FEEDBACK: Since 2001, Outsourcing Law & Business Journal™ has been addressing legal issues in operational excellence in business services through effective sourcing practices and service integration for global and globalizing enterprises.  Covered operations include business services in IT, HR, finance and accounting, procurement, logistics, manufacturing and customer relationship management. Send us your suggestions for article topics, or report a broken link at wbierce@biercekenerson.com. The information provided herein does not necessarily constitute the opinion of Bierce & Kenerson, P.C. or any author or its clients. This newsletter is not legal advice and does not create an attorney-client relationship. Reproductions must include our copyright notice. For reprint permission, please contact: wbierce@biercekenerson.com. Edited by Bierce & Kenerson, P.C. Copyright (c) 2013, Outsourcing Law Global, LLC. All rights reserved. Editor-in-Chief: William Bierce of Bierce & Kenerson, P.C., located at 420 Lexington Avenue, Suite 2920, New York, NY 10170, 212-840-0080.

A recent M&A decision by the Delaware Chancery Court reminds us all of the importance of carefully defining such scenarios.  In Winshall v. Viacom Int’l Inc., (Del. Chancery Dec. 12, 2012), the court ruled that the terms of an indemnification clause in an acquisition contract did not cover losses arising after the closing of sale.

THE INDEMNIFICATION TERMS IN THE MERGER TRANSACTION

The Winshall case arose out of the purchase by Viacom of Harmonix Music Systems, a developer of music-based video games, from Walter Winshall and other sellers.  The price was $175 million, but the parties agreed to put $12 million of the purchase price into escrow for 18 months after the closing to cover indemnified losses for claims by third parties arising from breaches of representations and warranties by Harmonix and its former stockholders.  There were three types of warranties that Viacom asserted to seek the $12 million in escrow:

•    IP Infringement.  The software for the video games did not infringe the intellectual property rights of any third party, and that Harmonix had, at closing, “adequate rights … as is necessary for the current use” of the Rock Band video game software that it had developed.

•    Operations.  The business operations of Harmonix did not infringe on the intellectual property rights (IPR) of any third party.  Harmonix represented that “neither the operation of the Business, nor any activity of the Company, nor any manufacture, use, importation, offer for sale and/or sale of any Current Game” constituted a violation of any third party IPR, except for patents and foreign trademarks.  The “Business” was defined as the “business as currently conducted” and did not include any future software development or any modifications to the software by Viacom as acquirer.

•    Knowledge of Infringement.  The seller’s top four executives had no actual knowledge of any infringement claim.

THE COURT’S DECISION ON INDEMNIFICATION IN M&A

The Delaware court granted the sellers’ motion for dismissal of the claims, even before trial.  Taking into account the facts in a light most favorable to Viacom, the court found that, as a matter of contract law, the merger agreement could not be interpreted to cover any losses or liabilities of Viacom as acquirer that were attributable to events occurring after the date of closing.

Software Infringement.   The court rejected the acquirer’s claim that the software infringement claimed by a third party was an indemnified loss.  The software had been in the process of development when sold, but Viacom completed the development.  “What Viacom was doing with Rock Band over a year after the merger closed cannot be considered ‘current use.’”  The third-party had sought damages from Viacom for the finished product, not the unfinished software.  The court noted that indemnification was intended to cover cases where the indemnifying party had control over the risk of infringement, not where the allegedly infringing product was completed by the acquirer-indemnitee.

Knowledge of Infringement.  The court accepted the affidavits of the former executives of Harmonix that they did not know of any alleged claims of infringement.  The court held that even if such executives knew of the existence of a third party’s patent, that alone did not rise to the level of knowing that such third party was asserting a claim of infringement.

BEST PRACTICES FOR INDEMNIFICATION

1.    Scope and Scenarios.  The parties should define carefully the scope, time reference points and contingencies in any indemnification clause.  The seller should be careful to exclude liability for events beyond the seller’s control, such as events occurring after the sale.  The buyer should identify the critical factors that it relies upon for freedom from future third party claims attributable to the seller’s actions or omissions.

2.    Insurance.  Liability insurance can be used to reduce or eliminate the personal liability of the indemnitor.  However, insurance for intellectual property infringement can be expensive, carrying a premium that assumes there will be substantial risk of loss.

3.    Pricing.   In any business transaction, indemnification can be useful to weed out problems that show up in differences of opinion as to pricing.  An earn-out contingency can be supported by an indemnification.   A director’s fees can be protected by “full indemnification” from lawsuits.

4.    Timing.  The time frame for indemnified events needs to be agreed and clearly expressed.   This is important since, in an M&A deal, the purchaser assumes control of operations, and the seller loses the tools to limit the occurrence of the scenario.

5.    Knowledge.  Representations that are limited to the knowledge of an individual are very tricky.  In a representation of “lack of knowledge” of a claim of infringement, does “knowledge” refer to receipt of a demand letter from the third-party claimant, or does it extend to “knowledge” that a third party has a patent claim that might be infringed by the seller’s product, software or service?  Does knowledge include suspicion of a possible infringement, receipt of a legal opinion suggesting there might be a claim?  These issues highlight the weaknesses of knowledge-based representations.

6.    Due Diligence.   Indemnification clauses should not be a substitute for due diligence.   Where the buyer has actual knowledge of an indemnified event, the seller should not be held responsible to pay the loss, since that could have been negotiated and repriced before closing.

7.    Compliance.  A sale of an asset crystallizes attention on the seller’s compliance program.  Typically, a buyer will want assurance that the seller has complied, before the sale, with applicable laws on such matters as registration of ownership, permitted uses of property being transferred or used, dealings with parties not legally permitted to do business (e.g., export controls), etc.  In licensing, each party will want a continuing compliance commitment by the other.  Without good compliance procedures for ordinary operations, the “indemnification” clauses will trap the company and its shareholders, reducing the value of their investment.

For more information, visit our pages on Risk Management and Contract Provisions.

Insights by Bierce & Kenerson, P.C. Editor. www.biercekenerson.com.

Vol. 12,  No. 8, December,  2012

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FEEDBACK: Since 2001, Outsourcing Law & Business Journal™ has been addressing legal issues in operational excellence in business services through effective sourcing practices and service integration for global and globalizing enterprises.  Covered operations include business services in IT, HR, finance and accounting, procurement, logistics, manufacturing and customer relationship management. Send us your suggestions for article topics, or report a broken link at wbierce@biercekenerson.com. The information provided herein does not necessarily constitute the opinion of Bierce & Kenerson, P.C. or any author or its clients. This newsletter is not legal advice and does not create an attorney-client relationship. Reproductions must include our copyright notice. For reprint permission, please contact: wbierce@biercekenerson.com. Edited by Bierce & Kenerson, P.C. Copyright (c) 2012, Outsourcing Law Global, LLC. All rights reserved. Editor-in-Chief: William Bierce of Bierce & Kenerson, P.C., located at 420 Lexington Avenue, Suite 2920, New York, NY 10170, 212-840-0080.

Deal Structure.   The company’s press release did not describe the details, but provided only an overview.  Under the agreements, Kodak will receive approximately $525 million, a portion of which will be paid by 12 intellectual property licensees organized by Intellectual Ventures and RPX Corporation, with each licensee receiving rights with respect to the digital imaging patent portfolio and certain other Kodak patents.   The portfolio includes about 1,100 patents.  Another portion will be paid by Intellectual Ventures, which is acquiring the digital imaging patent portfolio subject to these new licenses, as well as previously existing licenses.  In essence, a non-practicing entity (“NPE”, sometimes called a “patent troll”) will be buying the residual value of the patent portfolio and can demand that third parties (who are not part of the consortium) pay royalties for uses of the patented technologies.

Business Model.  The business model of this transaction validates the role of non-practicing entities in transactions to acquire and license technologies.  In this case, the model shows the value of “vulture capitalism” in finding undervalued intellectual property and buying it for resale (through licenses).   The transaction sets a standard for corporate users of such technologies and the financial power of NPE’s.

Litigation Settlement.  The transaction also includes an agreement to settle current patent-related litigation between the participants and Kodak, which avoids additional litigation costs.   The licensees include Adobe Systems  Inc., Amazon.com Inc., Apple Inc., Fujifilm Holdings, Google, HTC Corporation, Huawei Technologies (a Chinese company), Microsoft Corp., Research in Motion Ltd. (maker of Blackberry mobile phones), and Shutterfly Inc. (an online photo gallery).

Bankruptcy Exit.  The deal allows Kodak to substantially pay off debt associated with its bankruptcy and pension obligations to retirees. It will continue its commercial printing operations.

Impact on E-Businesses; Prospects for Non-Licensees.   The deal poses substantial barriers to entry, and operational risks, for companies that rely upon the processes covered by the patent portfolio.  Such companies can expect an increase in costs due to licenses that could be forced upon them by RPX Corp. and Intellectual Ventures.

Uses of KM.   Knowledge management is a basic tool for business process management (“BPM”).  KM may include training tools (webinars, questionnaires, checklists, algorithms).   KM can enable effective post-merger integration to two organizations by providing transparency into each other’s operations.  KM can also be used to capture the implicit, contextual knowledge of a retiring generation of experienced workers.  KM is applied in outsourcing, supply chain management (“SCM”) and business process management (“BPM”).  Other applications include business continuity planning (“BCP”), disaster recovery (“DR”), audit and control for corporate governances and regulatory reporting.

What is Knowledge Management?    Knowledge management (“KM”) represents the institutionalization of business knowledge derived from personal experience, and the continuous process improvement “on the shoulders of giants” by process designers.  KM applies scenario analysis to predict the suitability for applying a pre-determined process.   It is not ad hoc, but responds ad hoc to situational triggers.  Components to any KM process or system include:

• Scenario Triggers: precursor avenues leading to and funneling a work flow;
• Inputs: the collection of relevant data needed to provide either the context for a work flow (such as criteria for initiating the work flow) or the actual processing of inputs;
• Business Rules: the business rules (and regulatory requirements), or algorithm, processing inputs and delivering outputs as the intended results of the required operation;
• Data Processing: the process of applying the business rules to the inputs after the scenario is triggered and delivering the outputs;
• Records Management: the process of storing information in searchable formats, which may include a thesaurus, searchable links, and clusters of key topics and multiple documents (“records”).

Technologies Used in KM.  Virtually any digital technology can be used for KM.  This includes databases, repositories, intranets (open wikis or closed), extranets, decision support systems, project management tools, time billing and accounting software, web conferencing and online and offline storage systems.   With increasing mobility of computing devices and the use of social networks that can be used to diffuse information, and global cyber threats, KM poses cybersecurity risks to the enterprise.

Legal Issues in KM.    Several fields of law govern KM at different phases of creation, sharing, storage, use and reuse.  These legal fields cover issues in employment, intellectual property rights, trade secrets, corporate fiduciary duty, contractual restraints on competitive activities and related antitrust or competition law, privacy law, contractual rights on warranties and indemnification, and mergers and acquisitions.   In international business, the laws of multiple countries or multiple legal systems can apply, creating conflicts of law that require careful analysis and design for implementing a KM system or KM-based relationships.  Finally, governmental regulations can mandate the form of a KM system.

Employment Law.  Employees and contractors are sources of knowledge, as they take their experience and adapt it to specific problems for resolution.  Human resources departments must ensure that employees do not share knowledge that is subject to a non-disclosure agreement with a former employer or a customer.

Intellectual Property and Trade Secrets.   In the field of business services, a service provider uses work flows that could infringe the patent of a competitor.  Or it might use a trade secret for a purpose not permitted under a non-disclosure agreement.  Or it might present the work product in a form that is confusingly similar to the work product of a competitor under the Lanham Act or principles of “trade dress.”  KM tools and rules should include information about the sources and permitted uses of “knowledge” to avoid infringement litigation and to expand the scope of the organization’s proprietary (and thus competitive) operations.  In strategic alliances (such as teaming agreements and joint ventures) and outsourcing, both parties need to protect their own “KM” so that neither the outsourcer nor the enterprise customer can enjoy unfair competitive advantage after the end of the alliance or outsourcing contract.

Governmental Regulation.  KM has become a prime mandate of governments.  The Enron bankruptcy spawned the Sarbanes-Oxley Act of 2002, forcing public companies to maintain “audit and control” procedures beyond the general “best practices” previously adopted under generally accepted accounting principles (“GAAP”).  Under GAAP, Statement of Auditing Standards (“SAS”) No. 70 established procedures for auditors to verify that companies actually followed the procedures and work flows that they claimed to follow.  SAS 70 has since morphed into another auditing principle (SSAE 16), with a reduced standard of care and risk of liability for the auditors.   The Securities and Exchange Commission requires public companies to identify their vulnerabilities including risks of business continuity and processes for disaster recovery.  The Dodd-Frank Consumer Financial Protection law requires covered banks and financial services companies to adopt hundreds of specific processes, under over 300 regulations, to protect against risks of structural damage to the economy.

Getting Value from KM.   Managers can build enterprise value through KM tools and policies that promote increased efficiency, competitive positioning, transparency and accountability.  For efficiency, a “capability maturity” model may be limited in focus by addressing only constant improvements through analysis of “lessons learned” and proactive process redesign.   For competitive positioning, innovative, entrepreneurial managers can cast aside “inefficient” or complicated business models for new models based on new technologies.

Contract Clauses.  Virtually every business exchange involves the sale of some knowledge.  It can be embedded in a product, or it can be expressed as a means for using a product or consuming services.   Every contract for services (including “managed services” / outsourcing) needs effective analysis, planning and implementation of rules governing knowledge management.

Thinking Ahead.   KM principles are essential for any business.  KM contract clauses help ensure that the business will survive, thrive and adapt.