E-News No.45

E-News No.45

The court of Milan on IP assets’ devaluation due to tarnishment: the forensic accountant’s point of view on a damages’ assessment internationally-viable method by Simona Cazzaniga (Studio Legale Sutti – Italy)

The assessment of direct damages for the “tarnishment” of IP assets is one of the most controversial issues in the enforcement of IP. The problem is especially difficult when IP assets’ devaluation is concerned. Irrespective of the country or the judicial system concerned, determining the appropriate pecuniary compensation for the injured party is an awkward task.

Punitive or exemplary damages, wherever they are granted by local courts, are usually in proportion to loss of profits or consist in the disgorgement of profits. However, this concept only dilutes the need for a reliable method to determine correctly the degree of devaluation IP assets. “Equitable” assessments based on factors such as R&D or marketing costs are an effort to cope with the problem, but they also neglect the need for a more direct approach.

In most cases, the absence of a direct monetary measurement of IP asset’s devaluation is utterly evident: the hurdle seems to be the lack of a legally-acceptable calculation method.

That lack may appear weird to an accountant, accustomed to the severe rules of US GAAP (Generally Accepted Accounting Principles) in the USA and IFRS (International Financial Reporting Standards) in the EU and the rest of the world. Evaluating and devaluating assets is an accountant’s routine task, to be made according to clear and concrete rules, involving possible personal civil and criminal liability in financial lawsuits. Why should IP infringement trials be any different?

A recent decision of the Court of Milan (n. 7432/2015, “Flou” vs “Mondo Convenienza”, President: Marina Tavassi) has helped to fill this gap, “borrowing” the IFRS International Accounting Principles in an IP infringement case, on the basis of an expert witness opinion provided by a court-appointed forensic accountant, Dr. Andrea Vestita.

The logic is simple. Under IFRS, each year companies must re-assess how much their IP assets are worth according to the so-called impairment test, defined as the process of writing off all balance sheet values having no reasonable economic basis (IFRS 36). The Court of Milan stated that if an IP infringement causes a potential IP-asset writing off under IFRS, then that the amount written off can be considered as a legally acceptable measurement of direct damages for IP assets’ tarnishment.

Companies must proceed the assets’ impairment test at least in each financial statement, assessing their recoverable amount and then comparing it with their book value.

The asset’s recoverable amount is defined as the higher between“… the price that would be received when selling an asset […] in an orderly transaction between market participants at the measurement date …” (the so-called fair value) and “… the net present value (NPV) of a cash flow or other benefits that an asset generates for a specific owner under a specific use …” (the so called value in use).

The asset’s book value is defined as its last historical value written in a company’s accounting books, which is, in most cases, the value recorded in the last balance sheet.

Finally, the asset’s recoverable amount must be compared with its book value because the last, if higher, must be devalued to the first, so as to write off all balance sheet values having no-reasonable economic basis. This process is called impairment test.

Assessing assets’ recoverable amounts and proceedings the impairment test are compulsory standard duties in companies’ life, and they are strictly regulated by both IFRS an US GAAP in an almost identical way, at least for IP assets.

On this basis, the Court of Milan stated that direct damages can be awarded in the amount to be written off further to the results of the impairment test, obtained from ante- and post-infringement value assessment of the tarnished IP asset, assuming that the asset’s pre-infringement book value coincides with its recoverable amount at that time. In other words, damages can be liquidated as the difference between the asset’s recoverable amounts before and after the infringement. Therefore, the Court of Milan stated that direct damages arising from IP assets’ tarnishment can be assessed as a particular case of a standard (legal) IFRS procedure.

Interestingly, a claim on such basis could be actionable in many countries granting direct damages for IP assets’ tarnishment, since IFRS and US GAAP have practically a worldwide legal relevance.

IFRS are EU Regulations since the early 2000s, so having legal force in all EU Countries. US GAAP have in the USA – mutatis mutandis – the same force as IFRS in EU.

More than 100 non-EU countries require the use of IFRS by public companies, while most of other jurisdictions permit their use in at least some circumstances. Until now, the most relevant exceptions in this worldwide success story are China, India, Indonesia, Japan and Switzerland, but all those countries have been showing an actual interest in adopting IFRS in a near future.

Besides, US GAAP and IFRS have been converging for many years (albeit with many stops-and-gos) towards a common framework of accounting principles. This goal, though not completely achieved yet, seems within reach in the foreseeable future. Moreover, IP evaluation – which is obviously relevant to an infringement lawsuit – in IFRS and US GAAP are already almost identical.

Now, the IP court of Milan has stated that assessing direct damages for IP assets’ tarnishment on such basis meets all the legally necessary requirements.

From a forensic accountant’s point of view, time could be ripe for an internationally acceptable assessment method, capable of improving IP enforcement and of making specialised courts’ lives easier.