Micron, in disposing of patents to John Desmarais’ Round Rock Research, LLC, developed a plan that was simple in concept, although potentially complex in execution thanks to a desire to conceal the participation of its business partners. Nevertheless, Round Rock opponents exposed some of the mechanics behind Micron’s plan in public court filings (embedded below the article), while sources fill in some gaps that help bring the full transaction into focus.
At its core, Intellectual Ventures wanted Micron to take a license to its ever-growing portfolio, which Micron was loath to do. Meanwhile, Micron felt pressure to get value for an increasingly expensive patent portfolio. Both companies had their eyes on John Desmarais, who would be unlikely to leave the lush confines of Kirkland & Ellis without some assurances of success. A likely scenario bringing all of these pieces together includes both Micron and Intellectual Ventures (via a shell company) funding Round Rock’s patent acquisition, simultaneously keeping Desmarais’ newly formed law firm in business. In exchange for participation and a share of Round Rock proceeds, IV granted Micron a license, and sued some of its major foreign competitors.
The public facts are relatively straightforward. Micron sold 20% of its patent holdings to Round Rock, controlled by former Kirkland & Ellis partner John Desmarais. Micron pitched the idea, at least as far as Desmarais knows, and saved millions in expenses (including annuities, maintenance fees and, of course, attorney fees to manage it all) in the process. The announcement of the Round Rock purchase coincided with Desmarais’ departure from K&E and the creation of his own law firm. Previously, GametimeIP suggested that Intellectual Ventures played a role in Desmarais’ creation of Round Rock, because, among other coincidences, Desmarais filed Intellectual Venture’s first major offensive patent lawsuits shortly after leaving K&E, and Micron later announced that it acquired a top-shelf license from Intellectual Ventures, complete with access to IV’s portfolio should Micron need patents for defensive reasons. The IV license described in the Micron releases is very similar to the one Verizon received for a reported $350 MM.
Yet, no one outside the company knows how much Micron received for the Round Rock purchase, nor how much it paid for the IV license. Micron neglected to report either, seemingly material, event to the SEC, leaving many to speculate about what interests Micron or IV might hold in the Round Rock portfolio. Micron flatly denied having a financial interest in the Round Rock patents, but with good reason: it’s technically true.
According to a source familiar with the transaction, Round Rock likely paid for the Micron patents with a $400 MM promissory note. Of course, that, by itself, would not be enough to avoid Micron’s reporting requirement, which is why Round Rock likely signed a note specifically drafted to only amortize upon generation of revenue from the acquired patents. While the precise terms are impossible to know without access to the final, executed agreements, best estimates suggest the note obligates Round Rock to pay 20% of gross revenue exclusively related to the acquired patents.
While a publicly traded company cannot avoid reporting anticipated material future income from a promissory note in general, Micron could conceivably justify not reporting anticipated future income on this special type of promissory note since payment obligations are conditional and not guaranteed. In other words, Round Rock might end up owing absolutely nothing on the note, if its monetization efforts failed to produce any income. Potentially a gray area, given the possibility of significant, material income being generated by a publicly traded company, but most likely legal. Nevertheless, Micron perfected a security interest by filing a UCC Financing Statement in February 2010 (a copy of which is embedded below), identifying as collateral:
(i) the Round Rock Patents, as more particularly described in that certain Patent Sale and Transfer Agreement (“Transfer Agreement”) dated December 30, 2009 between Debtor [Round Rock] and Secured Party [Micron], together with … any proceeds thereof (including any proceeds derived from licensing of the Round Rock Patents or from the sale of the Round Rock Patents) …
[UPDATE: 5/9/12: The UCC filing flies in direct contradiction to Micron’s previous denial to IAM Magazine’s Joff Wild that “Micron sold patents to Round Rock and does not have an ongoing interest in or control over Round Rock.”] Tellingly, the Micron UCC filing also claims a security interest in “each deposit account which constitutes a ‘Revenue Account’ under that certain Patent Commercialization Agreement (‘Gemas Agreement’) dated December 30, 2009 by and among Debtor [Round Rock], IP Value Management, Inc. and Gemas Capital, Inc.” as well as an interest in deposit accounts created after Gemas’ security interest is terminated. Micron demonstrated awareness of an agreement between Gemas and IP Value to monetize the portfolio being transferred to Round Rock, and kept a security interest in the transferred patents and any future proceeds generated, a fact Round Rock admitted in January 2012 court filing (a copy of which is embedded below), disclosing IP Value, Gemas, and Micron as entities having an interest in the outcome of Round Rock’s litigation with SanDisk.
Of course, all of this raises two questions. First, if Micron financed Round Rock’s patent purchase with a promissory note, then what role did Gemas Capital play? Second, Samsung’s reported $300 MM payment to Round Rock potentially triggered payment of as much as $60 MM to Micron, yet Micron reported no such payments. Again, the reason that Micron reported no such income is, most likely, because it never received any. But if Micron didn’t, who did? And how did it avoid reporting all of this? It is possible that this is all an accounting trick—the “income” does not come to Micron as revenue but rather as a payment on a note, with the result that Micron’s cash balances go up (a balance sheet entry) and there is no effect on the Micron income statement. Crafty—and a very nice way to possibly avoid SEC reporting. More on that later.
Meanwhile, what does IV have to do with all of this? The patent aggregator likely had interest in Micron’s patents years ago, and was previously reported to have significant interest in obtaining Desmarais’ legal services. However, with top brass testifying before Congress about supposedly harmful effects of patent licensing, Micron would face a PR nightmare by simply handing over its patent trove and investing in a mass aggregator. To work out an acceptable deal, Micron’s internal IP group (the head of which is now working for Intellectual Ventures) would have to be creative.
Knowing that IV needed to give Desmarais a reason to leave K&E, that Micron needed a high-value license to IV’s portfolio, and that the late Steve Appleton wanted desperately to take out foreign competitors like Elpida (IV’s first direct litigation target) so Micron could pick through their carcass with plausible deniability, the mysterious promissory note is like the missing puzzle piece that brings the picture into focus.
The plan may likely have been as follows: Micron would assign an expensive chunk of patents, many of which it likely would have abandoned anyway, to Round Rock. In turn, Round Rock signed the promissory note. Micron, in turn, would assign the right to receive income from the note to Intellectual Ventures, possibly through payments to Gemas Capital. As Desmarais successfully monetized the Round Rock portfolio, Intellectual Ventures received the note payments. Either tied to a particular event (such as a future date, or possibly an amount of revenue collected), IV would later give Micron a full license to its portfolio.
Leading up to the announcement of the IV / Micron license, suspected licensees already included Sony, Apple, Nokia and Samsung. Round Rock held its eye-popping covenant not to sue auction on April 1, 2011, selling limited rights to the patents for $35 MM, potentially to Research in Motion. On April 28, HTC was dismissed from Round Rock’s initial lawsuits, suggesting another likely license payment. IV and Micron jointly announced their license agreement approximately one month later, on May 31st.
It’s already been widely reported that Gemas Capital funded Round Rock, but what remains unknown is who funded Gemas Capital. Two other suspects, besides Intellectual Ventures, are General Atlantic and Goldman Sachs, both investors in IP Value. However, the question remains, if Micron was willing to finance the patent transfer itself, why would another investment company be involved at the same time? One possible answer is to entice Desmarais away from the security and large salary of Kirkland & Ellis, and fund the creation of a well-staffed (and likely well-paid) law firm. After all, getting ownership of Micron’s patents is one thing, but to maintain something resembling a normal salary, not only for yourself but for a staff that largely came over from K&E, takes a significant capital investment.
However, this raises doubt about a possible General Atlantic or Goldman Sachs investment. First of all, in the United States, law firms are absolutely prohibited from accepting investment capital from non-lawyers, so neither investment fund could have put their dollars directly into Desmarais LLP. Beyond that, why would either fund invest capital in Round Rock just to watch Desmarais use it to fund a law firm that would be busy representing other clients? However, replace those funds with a unique, IP-based investment fund like Intellectual Ventures. Further, IV has every motivation to finance Desmarais LLP via Round Rock, so that Desmarais’ firm would be primed and staffed to handle numerous IV lawsuits.
Thus, the creation of Gemas Capital provided cover for both IV and Micron, enabling the latter to avoid receiving (and thus reporting) significant amounts of cash from its Round Rock interest. Meanwhile, Micron obtained a license to IV’s portfolio, again, without a significant cash investment.