IP Practice Moves in Mysterious Ways in Recession

January 2010

Maryland Bar Journal

This article is reproduced with the permission of the Maryland Bar Journal published by the Maryland State Bar Association. It was co-authored by Meredith Blake Martin of Astrachan Gunst & Thomas, P.C.

The Intellectual Property practice was long-thought to be recession proof. After all, hard times call for creative solutions, and necessity is the mother of invention. Past recessions seemed to bear this out. There were historic inventions borne of the Great Depression, including the Xerox® photocopier, the Schick® electric shaver and the Tampax® Tampon. During the last two recessions in the 1970’s and 1980’s, companies likewise sought to keep their market share with innovative new products. They ramped up R&D and became even more aggressive about protecting their intellectual property. Consequently, as the current decade began, law firm management consultants were praising the benefits of an IP practice as an all-weather stalwart.

The current decade will end on a different note. By the middle of 2008, rumors of recession were spreading. In mid-November 2008, the National Bureau of Economic Research announced that we had already been in a recession for a full year. Who knew? We had been enjoying peak economic activity in late 2007 and indicators had been at all time highs. The public watched in disbelief as credit markets seized, corporate budgets froze and layoffs began.

By early 2009, we were headed down the slippery slope and the world briefly panicked. Now, Federal Reserve Chairman Ben Bernanke says that the recession is “very likely over” because consumers seem to be spending again. Whether we remain in this grip or merely face its aftermath, the impact is tangible. Unemployment is high, and downsizing and cost cutting have become the business mantra.

The legal industry as a whole is facing an unprecedented decline in legal spending. The cuts have reached IP, as well as other areas traditionally thought to be insulated from economic downturns, and the specialty is no longer recession-proof. This recession, and its unique effects, signals not only a change in the normal business cycle, but also possibly a fundamental change in the current model for delivery of legal services, and possibly a larger change in consumer behavior and the definition of value within the economic model.

History Bears Repeating

Downturns are a recurring part of the economic cycle, for lawyers as well as the rest of the business world. From repetition, however, emerges pattern, and the patterns are fairly consistent within the legal profession across recessions. Overcapacity in the profession during times of recession is likely to be corrected by firm layoffs, dissolutions or pursuit of new practice areas. Despite the recession, certain areas have continued to grow: intellectual property, healthcare, employment law, technology and litigation practices.

Client pressures lead to alternative fee structures, and increased client direction over how matters are handled and by which attorneys within a firm. Out of desire or necessity, lawyers transition more freely between firms. These factors converge to bring about significant uncertainty and turmoil, while allowing opportunity for innovation and agility among firms able and willing to take this route.

That being said, legal environments can be countercyclical, depending on the nature of the practice. Attorneys focused on areas such as bankruptcy, insolvency, restructuring, labor, employment, commercial litigation or government relations should actually see work coming from the recession. Similarly, when the economy is bad, litigation booms.

This trend holds true for IP to some extent, although trends have shown that enforcement of IP rights may lag during a recession. Patent litigation grows, as more foreign companies, in particular, seek to protect their IP. Litigation also lends itself to the alternative fee arrangements that are so attractive to clients during recessionary times.

The IP Landscape

Traditionally, the thought has been that trends in the IP practice trailed the economy. Despite the beginning of a recession, companies had already allocated and would complete research and development projects that would create work for IP attorneys well into a recession. The slow-down, in turn, would hit once the funding dried up, well after the first pains of a recession were felt. In this recession, however, it appears as though there was sufficient warning of the economic downturn (in large part due to the credit crisis), to allow businesses to cut spending and prepare for lean times in advance.

Of course, many IP practitioners still speak with jaded optimism, but the numbers belie the truth. The number of patent and trademark filings in 2009 is lagging 16% behind last year because major corporations are cutting back (James Toupin, interim Patent and Trademark Office director, at a May conference). The PTO is self-funded by user fees and has likewise been forced to cut back.

It predicts a $200M shortfall in FY2010, and currently has suspended overtime pay and instituted a hiring freeze. According to Stanford Law School’s IP Litigation Clearinghouse, new patent infringement complaints were down 8% in 2008, and 23% over the last quarter of 2008 and first quarter of 2009. A recent BTI Consulting Group survey concluded that a majority of corporate counsel at Fortune 1000 companies still plan to cut IP litigation spending by another 7.7 percent and prosecution spending by 4.3 percent. Many IP law firms are hurting while some are bleeding.

In February, the New York IP boutique Morgan & Finnegan dissolved and filed for bankruptcy. Some of our largest IP law firms have reported layoffs, including Boston’s Fish and Richardson. Local Baltimore firms have likewise been cutting staff, reducing lawyer salaries, delaying the start date of new associates, canceling summer programs and taking back job offers.

Nonetheless, diversity and necessity within the IP practice is lending buoyancy and optimism for the resilience of the practice area. Litigation is one area of law that is typically recession proof and IP litigation does not appear to be entirely an exception to this rule. Budget constraints may result in some attrition in companies’ aggressiveness towards IP enforcement.

There is a certain baseline of IP work that will be maintained despite a recession, although this particular recession seems to buck that theory to some extent. Companies will protect their principal brands and marks, although they may be lax with respect to less-important IP due to budgetary constraints. Companies will still engage in the necessary steps to protect inventions (although the research and development process may be slowed), and companies will still engage in litigation to protect IP (although cost may be a factor in choosing which battles to fight).

In addition, new subspecialties within IP continue to emerge and flourish. Consider, for example, the birth of the Internet and/or software lawyer following the late-90’s boom. This subspecialty is one that continues to grow despite economic turmoil -- largely due to increasing use and commerce via the Internet. Also, IP is increasingly recognized as an asset class and one that has largely held its value while other asset classes have spiraled downward.

Commerce related to IP as an asset class also has created new work for IP lawyers. Increasingly, business owners are relying on their attorneys, not only for transactional work related to IP, but also to provide business counsel in this time of economic turmoil. Despite optimism, however, it is clear that the IP practice has been affected by this recession in ways neither anticipated nor seen before.

Why This Recession is Different

What exactly happened this time around to break the IP industry armor? To answer this we need to consider the underlying dynamics of IP spending. Large corporations, educational institutions and government organizations typically maintain consistent IP budgets despite an uneven economy. Small and mid-size corporations are also buoyant as they realize that “better, faster and cheaper” is the key to surviving a downturn.

Indeed, most management consultants warn against cutting back on R&D, marketing or IP protection when times are bad. Independent inventors also hold steady. For each individual that loses his/her job and stops spending, there is another afraid of losing their job who invests in IP and hopes for supplemental income or an unemployment hedge. Foreign corporations do not mind the weakening U.S. dollar and they keep spending as well. Only venture-capital fueled businesses tend to cut back. All in all, these dynamics historically balanced out, and overall IP spending remained fairly steady through past recessions.

This time we are facing “the perfect storm” of a recession, fueled by the U.S. mortgage crisis which has lead to a severe credit and liquidity crunch, falling stock markets and high oil prices. The IP spenders have behaved differently. Budget-driven large corporations already had their status quo budgets in place late in 2008. These budgets were hastily retracted, and non-essential spending was frozen until the budgets could be revised.

In-house patent counsel, under pressure from their COO’s to minimize IP costs, were called to task. IP spending remained at minimal levels through the first quarter of 2009. Eventually, new “hunkering down” budgets were implemented that cut 5 percent to 20 percent from fiscal year beginning July 1, 2009. For small and mid-size corporations, the credit markets were (and still are), especially brutal.

Banks abruptly recalled small business lines of credit, and this knee-jerk reaction cut deeply into R&D spending, IP spending and everything else. Venture capital-based IP spending hit a brick wall, down 47 percent from the fourth quarter of 2008 and the lowest level since 1997 (National Venture Capital Association). As investors pulled back funding, the biotech industry suffered and their IP spending dwindled. Educational institutions rely on venture capital for their spin-offs, plus royalty income from licensees.

However, the venture capital well was dry until recently, and corporate licensees have been busily trimming their IP portfolios and terminating (or not renewing) university licenses. Only independent inventors remained steady, still looking for supplemental income or a moonlight business. Add it up and this time, as with most of the legal profession, the practice faces an unprecedented decline in IP spending.

Also relevant to the particular, somewhat unique effects of this recession are factors outside of the legal arena, such as changes in technology, shifts in client demands and severity based on geography. Technology allows for an increase in the efficiency of law practice, whether it be by reducing travel costs, reducing the costs of communication with and conferencing with clients (e.g., by teleconference or the like), or reducing overhead costs related to training and continuing education (e.g., by utilizing tools such as webinars in lieu of in-person seminars).

Advances in technology make constant communication a reality. Clients expect this increase in efficiency to pass through in terms of costs, and also expect the near-immediate responsiveness that new technology allows. These factors, together with the fundamental changes to our financial system that have emerged from this recession, signal that the economic events of 2008-2009 may not simply be wiped out by the next upturn in the business cycle, but rather may dictate a fundamental change in how businesses (including lawyers), serve their customers and clients.

Where Are The IP Lawyers?

At one point, IP lawyers, particularly those serving large corporations, could be found in large firms having offices throughout the United States, or even the world, hundreds or thousands of lawyers, and the extensive overhead to match. The present economy has challenged that business model that has forced layoffs, and even dissolution, among such large firms. Transitions in the IP industry will continue, both voluntary and involuntary.

Senior associates often bear the brunt of involuntary cuts because recessions tend to constrict the partnership funnel and clients prefer the lowest possible billing rates attached to their partner’s support team. Voluntarily, some large firm billing partners will migrate to smaller firms to relieve the rate pressure on their clients. However, these will barely amount to trends. The biggest and most newsworthy impact by far will be felt by the law school graduating classes of 2009 and 2010. Once lured by the promise of $200K salaries, the landscape has changed completely for law school grads. Few firms are hiring.

Many attorneys looking for a different practice setting as a result of this recession are choosing to start solo or small firm practices and create a new breed of “Big Law” solos. These attorneys are distinct from the traditional solo and/or small firm model, as they have a narrow and deep expertise in their practice area, as opposed to a more general and wide knowledge of a variety of practice areas.

Both the “Big Firm” solo’s and traditional solo’s (or small firm lawyers), are generally able to offer more personalized client service at more reasonable rates than larger law firms. As part and parcel of this trend, traditional solo’s and small firms are facing much stiffer competition for clients as these highly specialized attorneys enter the local and regional marketplace from larger firms.

How Are Firms Responding

Small to mid-sized firms have, in large part, become beneficiaries of clients’ seeking quality legal services at lower rates, and their current practices in terms of billing and client services are in line with client demands in this tight economy. On the other hand, this segment of the market has become much more crowded (and competition more fierce), as top-notch, specialized attorneys leave “Big Law” to enter small or mid-sized firms.

Large firms have been forced to respond to the economy by cutting their own costs (including through layoffs), and, adopting some of the hallmark business practices of their smaller counterparts. “Big Law” now competes not only with other mega-firms, but also with the regional firms now housing many veterans (or refugees) of “Big Law.” Large law firms who once dictated rates to clients and trained associates at the expense of clients, are now forced to take direction from clients as to how fees will be charged and how cases will be staffed in order to remain competitive with regional firms.

Alternative fee structures are increasingly agreeable to big firms, whether in the form of discounting the billable hour rate, offering flat fees, incentive fees, contingency fees or creating a hybrid method of billing. All firms are now being called on to take a more client-oriented approach such as producing budgets for legal work.

Marketing to the IP Client in a Recession

As the recession has brought to bear a shift towards negotiation between lawyers and their clients, similarly, lawyers are in a better position to negotiate with respect to their own marketing expenses. Traditional methods of marketing, such as sponsorships and advertising, are negotiable (e.g., a sponsor can demand more in exchange for a sponsorship in the current economic climate, and should be able to obtain better rates for advertising). Particularly significant for IP lawyers (generally marketing to tech-savvy clients), is the growing ability of firms to market aggressively and inexpensively online through web sites, blogs, online or electronic publications, and social media.

The Forecast

The good news: lawyers are always needed when there is a disruptive change of circumstances, whether it be within a company, family, opposing parties or the economy at large. To some degree, the legal profession is insulated to the extent attorneys and firms are willing to retool and make adjustments to reflect the current state of affairs.

This is an immutable fact: the American economy is resilient. Perhaps the recession is over, perhaps not. In either case, the “end” will be marked by a transition and not immediate recovery. The economy will continue to shed jobs. Federal Reserve officials expect the pace of the recovery to pick up in 2010.

The bond market is breathing again, but only for investment-grade companies. The outlook will remain dim for smaller companies for quite some time. Until small businesses can get credit, the IP practice will continue to suffer and will likely face at least another year of difficulty.

If it hasn’t already, the recession will soon end. IP spending will increase, law firms will realize a shortage of manpower and the entire ordeal will pass like a cold winter breeze. In passing, it will have some positive impact. Upcoming generations of lawyers won’t wear a sense of entitlement. Lawyer marketing will shift away from elitism to a value proposition.

More importantly, heightened competition for jobs and clients will force IP lawyers that still have both, to be better. They will become more aligned with their clients and strive for “better, faster and cheaper” in their own right. This will elevate the “best practice” of IP law.