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i4i won a huge legal victory. But at what cost?

U.S. Patent No. 5,787,449 is a white-knuckle read: Method and System for Manipulating the Architecture and the Content of a Document Separately from Each Other is only the breathtaking title. It goes on but I'll spare you because the real story is the fight over the patent, which pitted Microsoft against a private Canadian company.

The moral of the story: Investing in patents is no country for old men.

Ask Loudon Owen, who is happy today but has sweated a few bullets since the dispute began about five years ago.

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Mr. Owen is the chairman of i4i LP, the plaintiff and victor in the lawsuit, and a managing partner of McLean Watson Capital, which is a big investor in Toronto-based i4i. He's also an avid amateur mixed martial artist and his firm has a stake in The Fight Network, which features people hitting each other 24/7.

Mr. Owen is no stranger to a fight, but he had never stepped into the ring with an 800-pound gorilla before. Patent fights are brutal, expensive and can easily wipe out a small plaintiff. Why would i4i do it?

Mr. Owen says when his firm invested in i4i 13 years ago, "I promised that I would do everything I could to make it a success. You have to be careful what you say in life."

Things went well early on. The company's technology, which works invisibly to organize huge amounts of data for governments and big companies, was gaining traction. It looked like a home run. But by 2002, sales dried up fast. The company wasn't sure why, but soon suspected that Microsoft, its partner, had built the patent into its new version of Word and companies could use it without paying i4i anything. But i4i had no proof, because the company didn't have access to the code.

The only way to know for sure was to launch a legal action, not a decision a small firm takes lightly given the high cost of these fights. Intellectual property experts told him not to do it. But they decided there was no choice, so they sued Microsoft in 2007.

The next couple of years were tense ones. The company hired a couple of law firms on a hybrid payment system, part retainer, part contingency - expensive. But it also did a smart thing by bringing in a co-investor, Northwater Intellectual Property Fund, which invested in i4i and provided what Mr. Owen describes as invaluable legal expertise.

As the headlines make clear, the gamble paid off. The company won a judgment of $290-million (U.S.); more impressive is $40-million in damages because the U.S. judge found that Microsoft infringed on the patent willfully. And even more impressive is that the judge slapped a permanent injunction on Microsoft, meaning it has to permanently remove i4i's technology from its software (it has a couple of months to comply).

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"That's more valuable than the award itself," Mr. Owens says.

Microsoft says it's disappointed and will appeal. This is clearly a victory for i4i in the legal world. But in the economic world, it's less of one.

First, the judgment is based on an estimate of what Microsoft would have paid to license the technology and interest thereon (plus the punitive portion for willfulness). It seems to me that i4i would have been better off had Microsoft simply signed a licence and paid its bill, giving i4i cash flow and time to develop new business or new patents.

On top of that opportunity cost is the amount of human capital that i4i and its backers had to devote to this suit. And there's the dilution of bringing on a partner to help out.

It fought a brave fight and won a judgment - of which it will get about 65 per cent and will quite possibly earn a lot of revenue from future licences. But it also paid a price.

That hints at the rub of investing in intellectual property. I obviously can't speak for Microsoft, which would never admit to willfully infringing on intellectual property. But it might have a rational incentive to do so. Seven years ago, it wasn't clear if i4i's technology had long-lasting utility. Microsoft might have been looking at 100 patents at the time; it could pay a licence on each one, or it could just start using them and pay for the ones that pay off later, when they've proven useful.

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That might work out for the big company but it's difficult, and sometimes fatal, for the small firm. Investors should remember that. Patents have value only if their owners have the resources to defend them from infringement.

In the meantime, Mr. Owen is relieved that his legal fight is over and he's looking forward to unwinding by sparring in the gym. "I just want to get in the ring and hit someone."

Fabrice Taylor is a chartered financial analyst.

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About the Author
Investment Columnist

Fabrice Taylor, CFA, publishes the President’s Club investment letter, for which he and The Globe and Mail have a distribution agreement. More

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