Liability of managing directors in view of patent infringement and D&O policies in Germany

Executive summary

Liability resulting from patent infringement poses a major challenge for the business of a defendant company. Besides having to cease and desist from selling the affected product or using the affected process, the defendant company will also face claims for damages, recall and destruction. The managing director is the key person responsible for the actions and business decisions of the defendant company. The managing director’s responsibility goes hand in hand with a significant liability risk, so that it is not uncommon that the director is sued alongside his company. Likewise, the company may turn against its own director after having paid out to the claiming patentee. Therefore, D&O insurers have an interest in getting involved early when patent litigation is threatened and develop a suitable defence strategy.

Introduction

Managing directors of companies which are accused of patent infringement are usually co-sued by the patentee. This causes direct liability for the managing directors. Aside from the liability of the company/managing director towards the litigating patentee, the legal relationship between the defendants (meaning the company and its director) can become sensitive should the proceedings worsen and threaten a negative outcome for the defendants. At the latest, when a negative judgement is handed down, the issue of the potential liability of the director towards the company will arise. When it comes to the liability of managing directors, D&O policies will frequently become relevant and the evaluation as to whether such policies respond to the claims raised becomes a key question.¹ D&O policies are usually taken out by a company to cover claims brought against the manager or director from third parties and the company itself. In other words, when the director is held liable for a negligent breach of his duties, the D&O insurer is likely to get involved.

Patent litigation in Germany

To understand the far-reaching implications of patent infringement proceedings – particularly for D&O-insurers – it is crucial to get an overview of the key legal aspects of patent proceedings in Germany. Where patent litigation is concerned, Germany is a well-recognized jurisdiction for initiating patent infringement proceedings. Due to the patentee-friendly “bifurcated system”, specialized patent chambers with judges who possess good technical knowledge, predictable costs as well as speedy proceedings make Germany by far the most frequented forum for patent litigation in Europe.

a. Bifurcation between infringement and validity proceedings

“Bifurcation” means that there are separate court proceedings for infringement and validity of a patent. It is in the exclusive competence of the European Patent Office or the Federal Patent Court to decide on the revocation of a patent, while the specialized patent chambers of selected civil courts establish whether a patent has been infringed, which would entitle the patentee to claims such as injunction or damages (Sec. 139 et. seq. German Patent Act). Therefore, patent litigation frequently consists of extensive “bifurcated” proceedings and the involvement of legal as well as technical experts. Besides specialized lawyers, who represent the patentee or the defendant in the civil court proceedings, patent attorneys and other technical experts are important for challenging or defending the validity of the patent-in-suit. Thus, patent litigation triggers extensive costs solely for the proceedings.

Besides the defendant company, which is the main target of the patentee, it is common for the managing director also to be sued for patent infringement. The courts do not require the patentee to make any special submissions to assume the liability of a managing director. A breach of duty of the managing director towards the patentee is usually implied when the defendant company infringes the patent. This low threshold is satisfied as a result of the general responsibility of the managing director to ensure compliance and his duty to respect third party patent rights in of the course of business decisions.² It is the responsibility of every company and, respectively, its managing director to check whether the envisaged product could infringe a third party patent before starting production or distribution.

b. Asserted claims

The claims regularly asserted in patent proceedings are as follows:

• Injunction
• Damages (in connection with rendering of account)
• Recall
• Destruction

All the aforementioned claims can be asserted against the defendant company. The managing director of the company, however, will only be subject to injunction and damages claims from the patentee. In terms of damages, the managing director and the defendant company are jointly and severally liable. Claims concerning the recall and destruction of the infringing products can only be asserted against the defendant company.

The quantum of damages can be calculated by three different methods. It is open to the patentee to select the preferred method. The methods are (i) lost profit, (ii) hypothetical licence fees and (iii) profit of the infringer. However, in nearly every case, the claim for damages is enforced solely against the defendant company.

A claim for recall requires the infringer to make reasonable efforts to withdraw the infringing products from the market. By recalling the infringing products, the infringer will have to refund the payments received for those products. Besides paying back the purchase price, the infringer has to deal with loss of reputation.

Once the patentee requests destruction, the infringer has to make sure that all infringing products in his possession are made unusable. This regularly requires the destruction of the products in stock as well as the products received in the course of the recall. However, the claim for destruction is not limited to the infringing products. It even includes materials and devices which are mainly used for production of the infringing products (cf. Sec 140a para. 2 German Patent Act). Although the claim for destruction has to be reasonable, the assertion and/or enforcement of the claim for destruction is only infrequently considered unreasonable by courts.

c. Interim conclusion

Patent claims pose a major risk for the defendant company. In addition, the managing director often also faces liability towards the patentee in cases where patent infringement is established due to the rather low requirements imposed by the courts. However, the managing director in his personal capacity is liable towards to the patentee solely for injunction and damages.

It should be stressed, however, that the claims for recall and destruction (which are addressed only against the defendant company) can also entail a major loss which, as a second step, may be the subject of a recourse claim against the managing director.

Salient considerations for D&O insurers

When a patentee is claiming patent infringement against a company and/or its managing director, it is not only the affected parties who should take preparatory steps. The relevant insurer should also establish its defence strategy. Each time a third party (e.g. a patentee) or the company claims against the managing director, the D&O insurer is potentially exposed to coverage under the D&O policy. The evaluation of the case and the preparation of a defence strategy should begin immediately after the policyholder provides notice of the circumstances or a claim notice, particularly taking into account the following considerations.

a. Potential damages falling within the scope of director’s liability

A typical D&O insurance policy would usually cover all claims against the competent director resulting inter alia from its breach of duties in its capacity as a director. Such claims may be brought by either a third party or even by the director’s own company in the case of recourse claims.

A claim for damages against the managing director (which, consequently, is relevant for the D&O insurer) requires a culpable (i.e. at least negligent) patent infringement. When determining whether a culpable act can be established, one has to distinguish between the duties of the competent director towards its company and certain duties towards the claiming patentee. Compliance with the director’s duties towards the company becomes particularly relevant in connection with reimbursement claims by the company against its director, where the latter had not exercised the required degree of diligence when representing its company externally and, thus, clearing the ground for a valid third-party claim of a patentee.

Although higher German case law is not fully consistent with regard to the particular scope of directors’ duties, in most cases an actual patent infringement would result from a breach of the director’s direct duty to maintain (and cause its company to maintain) compliance with laws and third party rights (such as patents).

It is important to note, however, that the scope of duties may vary depending on whether the patentee is claiming against the director directly for an asserted infringement of patents or whether the company is bringing recourse claims against its director after paying out to the successful patentee. Such disparity in the scope of liability is fundamental in cases where a patentee has successfully claimed only against the company and the latter is turning against its director to claim recourse for culpable breaches of the director’s duties towards its company. Comparable issues as to the scope of the concrete duty might further arise if the director was not in charge during the entire period in which the infringement took place, or if several directors and managers shared responsibilities.

Although the relevant duties in connection with patent infringements have to be evaluated on a case-by-case basis, some common scenarios may be identified, e.g. when introducing a new product to the market. Generally, before commencing distribution of a new product, a director would have to obtain freedom-to-operate opinions from patent attorneys or specialized lawyers and/or consult with the companies’ internal patent experts (depending on the individual case and taking into account the particular business structure, size and orientation of the relevant company) in order to discharge its general compliance duties. Even where these steps are taken, the risk of infringing affected patents cannot be completely ruled out. Then, however, there might be a valid argument that the infringement did not arise from a culpable breach of director’s duties, in which case the director (and, consequently, the D&O insurer standing behind him) could not be held liable.

b. Potential damages falling within the scope of director’s liability

Besides the losses resulting from cease and desist and damages claims, significant costs in connection with patent infringements often arise from recall and destruction claims (which can only be claimed against the defendant company). That is because such claims may not only involve the recall of a large amount of infringing products across a large territory but also the destruction of very valuable production facilities. However, a patentee’s claim for damages and an injunction is more likely to be considered ‘reasonable’ in comparison to recall and destruction claims.

Although a patentee could not claim for the recall and/or destruction of the infringing products against the director directly, the insured company might subsequently make a claim against its director for the costs of a product recall and thereby extend or trigger an insured event under the D&O policy. From the perspective of an insurer, it is therefore crucial to assess the potential implications of each claim and react by adjusting and amending its defense strategy in a timely manner.

c. Defence costs

Many D&O insurers provide comprehensive coverage of legal costs which arise in connection with a claim against the policyholder or its insured director (being the insured person). Some D&O insurers would also reimburse legal costs for the preparation of an adequate legal defence even if a claim against the insured director is only threatened (but not yet asserted). Since patent litigation and thus the defence of patent claims is simultaneously complex and costly, a significant amount is usually at stake for the insurer. Depending on the actual insurance scope, the Insurer may not be obliged to cover all legal costs that arise in connection with a patent claim.

In general, a typical D&O insurance policy would cover legal costs relating to the defence of an insured managing director but not the costs that arise in defending the company itself. Depending on the individual case and the type of claim, a larger part of the defence costs may be dedicated to the defense of the company instead of the insured manager (e.g. if recall and destruction claims are brought against the insured company alone and not against both the insured company and the director).

It should be stressed, however, that some D&O policies contain allocation clauses pursuant to which the Insurer undertakes to bear the legal costs for the defence of the company as well, if certain criteria are fulfilled (e.g. if the legal defence is conducted by the same law firm, or the same type of claim is brought against the insured company and insured director).

d. Potential mitigation measures resulting from the German bifurcation principle

A further important aspect to bear in mind is the bifurcation principle under German patent law and the potential legal costs associated with the nullity proceedings. Since the insured director himself is typically not party to the nullity proceedings (if such proceedings are commenced), the D&O insurer would generally not have to cover costs associated with such proceedings. It should be stressed, however, that – depending on the case at hand – the insurer may want to have nullity proceedings initiated for strategic defense purposes and in order to avoid or mitigate the actual damage. In these cases, the insurer would have to bear the costs of the nullity proceedings pursuant to Sec. 83 of the German Insurance Contract Act.

Given the significant costs associated with such proceedings, it is crucial for D&O insurers to carefully evaluate and assess the legal situation early in the claims handling process, not only from a coverage but also from a patent law perspective. This is even more so where invalidity is claimed in opposition procedures before the European Patent Office. In the first 9 months after the granting of the patent, it is only possible to challenge the validity of a patent by an opposition at the European Patent Office.³

e. Potential further coverage aspects

Due to the complexity of patent disputes, the scope of some other insurance products may also be affected by patent infringement scenarios. Aside from specialized IP policies which aim at insuring the policyholder against financial losses suffered in connection with infringement law suits and IP invalidation proceedings, W&I insurance products may also apply in cases where the relevant company was the subject of a recent transaction.

Another factor worth considering is that patent infringements are usually sustained throughout a long period, whereas D&O insurance policies are designed as annual claims-made policies focusing on the point in time when the actual claims were raised against the managing director. However, German D&O policies provide for so-called extended report periods (Nachmeldefristen) during which a particular claim may also fall within the scope of the previous year’s policy instead of falling within the policy of the current year.

Finally, it should be stressed that a thorough investigation and evaluation process is key to a successful claims handling process, especially in the context of patent infringements. This not only applies to issues and arguments relevant to the validity of the claim against the director himself but also to potential exclusions and certain insurer rights (e.g. termination or withdrawal) that might apply if certain facts underlying the patent infringement were already known to the insured company prior to the inception of the policy.

Conclusion

With regard to the major impact of patent litigation and the associated risks for the managing director, D&O insurers should ensure that they are involved as early as possible in any patent litigation. This can be achieved by instructing a monitoring counsel or by the appointment of a patent litigator.

In view of the significant legal costs that may come with such patent litigation, the following considerations should be borne in mind when determining the defence strategy:

• Although a patentee would not claim directly against a managing director for the recall and destruction of products, the defendant company may claim against its director afterwards if a breach of managerial duties is in question.
• It should be thoroughly evaluated which legal costs are covered by the relevant D&O policy and whether, for example, nullity proceedings should be initiated for defence purposes.
• Specialized IP policies and older or newer D&O policies may also apply and potentially cover a portion of the incurred costs.

Finally, to identify and mitigate the risks of patent litigation, the D&O insurer may also request adequate freedom-to-operate opinions with regard to the products which the company is producing and distributing.

The authors of the article are: Clemens Rübel, Dr. Sven Förster, Maximilian Schmitz, LL.M. and Dimitri Schaff.