TLQ Vol3 Issue4 E

Co-Counsel

McCarthy Tétrault Co-Counsel:

Technology Law Quarterly Volume 3, Issue 4

October – December 2007

Co-Counsel: Technology Law Quarterly Volume 3, Issue 4

Welcome to Volume 3, Issue 4 of McCarthy Tétrault Co-Counsel: Technology Law Quarterly. In this issue of the TLQ, we bring you information about a number of key topics:

We provide an update on the status of amendments to the Québec Consumer Protection Act relating to distance contracts. We also discuss new regulations that will remove a significant barrier to certain forms of e-commerce in Québec.

On the privacy front, we review the privacy commissioners’ findings and recommendations regarding the breach at TJX Companies, Inc. The intrusion reportedly involved millions of credit and debit card numbers, as well as other personal information of shoppers. We also report on another high-profile privacy breach — this one at the Passport Office.

With the costs of data security breaches mounting and the frequency of identity theft growing, legislatures are taking action and we highlight several developments in this area. One article discusses amendments to the Criminal Code introduced by the federal government. If passed, these amendments will create offences for unlawfully collecting, possessing or trafficking in identity information. Another article reviews legislation in Minnesota prohibiting retailers and other merchants from retaining credit or debit card security data of Minnesota residents after authorizing a transaction. The new law, once in effect, will also permit banks to sue a company for costs associated with data breaches.

We discuss a recent US decision striking down two provisions of the USA Patriot Act as unconstitutional because they violated the Fourth Amendment’s guarantee against unreasonable search and seizure. We also note that Québec and B.C. had enacted legislation restricting the flow of personal information outside their borders in response to concerns over the Patriot Act’s extraterritorial application. On the flip side, we review a decision in which the Canada Revenue Agency (CRA) succeeded in getting access to records located in the US. The Federal Court required eBay Canada to provide the CRA with information on its ‘PowerSellers,’ even though that information was stored on servers outside Canada.

On the intellectual property (IP) side, our lawyers comment on the complaint filed by the US with the World Trade Organization (WTO) on Chinese IP laws. For organizations without an IP strategy in place or just starting to develop one, our 15 tips for protecting and enhancing your organization’s intangible assets will be of interest.

In the area of tech finance, we continue our series on taking your tech company public, outlining the potential downsides to being a public company. This issue also features articles on the Ontario government’s establishment of a venture capital fund and its proposal to extend the phase-out of tax credits for labour-sponsored investment funds.


While this issue concludes our series on regulatory matters affecting VoIP technology, we have started a new three-part series focusing on the basics of offshore business process outsourcing (BPO). In this instalment, we explore the related business trends and strategies of BPO from a legal perspective. We also continue our four-part series on the effect of new technology on Canadian cultural media products. This time, we examine the impact on film production and distribution. We consider whether, in the face of domination by Hollywood blockbusters, technological changes will help or hinder independent Canadian titles.

In the biotech sphere, we discuss some issues for licensors and licensees when structuring royalties on sublicensing revenues to licensees from the licensed technology. We also report on Canada’s distinction as the first country to issue a WTO compulsory licence to export a generic drug.

These and many other key topics are discussed in this issue of the TLQ. Browse through the publication using the table of contents, which contains ‘clickable’ links to articles. All the articles can also be found on our website. You can search our publications database and find additional informative articles on many subjects. If you would prefer to receive a paper copy of the TLQ in the future or wish to change your subscription information, please contact me at the link below.

McCarthy Tétrault is proud of its position as a leader in all areas of law. The Canadian Legal Lexpert Directory 2007 has recognized McCarthy Tétrault for having the premier technology law practice in the country. The Chambers Global: Guide to the World’s Top Lawyers 2007 has confirmed McCarthy’s top ranking in Canada for technology, media and telecom (TMT). Co-Counsel: Technology Law Quarterly is one more way we are working hard to retain that position of leadership.

Heather Ritchie Editor-in-chief January 2008

http://www.mccarthy.ca/lawyer_detail.aspx?id=6684

http://www.mccarthy.ca/home.aspx


Table of Contents

Internet/E-World .................................................................................. 1

E-COMMERCE............................................................................................... 1 Canada: Cyber World Group Pleads Guilty to Illegal Gambling ............................................1 Québec: Bill 48 — Recent Amendments to the Québec Consumer Protection Act ......................2

SOFTWARE LICENSING.................................................................................... 3

International: Open Source Software and Open Content Licensing: From Copyright to Copyleft — Part II ...........................................................................3

Technology Finance............................................................................... 8

TECH-RELATED FINANCE ................................................................................. 8 North America: Taking Your Tech Company Public — Part II ...............................................8 Ontario: Venture Capital Developments ..................................................................... 11

Technology Contracting.........................................................................14

OUTSOURCING............................................................................................ 14 International: Offshore Business Process Outsourcing 101 — Part I ..................................... 14

Intellectual Property ............................................................................18

COPYRIGHT ............................................................................................... 18 Canada: Sookman Responds to Geist ......................................................................... 18 International: WTO Challenge to China’s Intellectual Property Protection Regime .................. 18

PATENTS................................................................................................... 19

Canada: Top 15 Tips for Protecting and Enhancing Your Intangible Assets ............................ 19


Privacy .............................................................................................21

CASES/LEGAL DEVELOPMENTS ......................................................................... 21 Canada: Privacy Commissioners Rule on High-Profile Privacy Breach................................... 21 Canada: Passport Office Suffers Privacy Breach............................................................ 23 Canada: Federal Government Introduces Criminal Law Reforms to Target Identity Theft .......... 24 Canada: eBay Canada Required to Provide Information on PowerSellers to Canada Revenue Agency........................................................................................ 25 US: A New Trend in Liability for Security Breaches? ....................................................... 26 US: Two Provisions of the USA Patriot Act Declared Unconstitutional.................................. 28

Communications ..................................................................................30

CASES/LEGAL DEVELOPMENTS ......................................................................... 30 Canada: Canada Announces Policy Framework for the Auction of Advanced Wireless Services (AWS) Radio Spectrum........................................................ 30 Canada: Canadian Cultural Product and the Long Tail: The New Economics of Production and Distribution in Canada — Part II ............................... 31 International: Voice over IP Services — Regulatory Perspectives from the Developed and Developing Worlds — Part IV ................................................................ 37

Clean Technology ................................................................................42

CASES/LEGAL DEVELOPMENTS ......................................................................... 42 Canada: Climate Change, Clean Tech and Innovation — Leading by Example ......................... 42

Biotechnology/Life Sciences ...................................................................44

CASES/LEGAL DEVELOPMENTS ......................................................................... 44 Canada: Biotech Licences — Sublicensing Revenue Considerations ..................................... 44 International: Canada Is First to Grant WTO Compulsory Licence for Export of Generic Drug ......................................................................................... 45


Internet/E-World

E-COMMERCE

Canada: Cyber World Group Pleads Guilty to Illegal Gambling

In late November 2007, the media reported that Cyber World Group (CWG) had pled guilty to charges of illegal gambling in Québec and had been ordered to pay a $2-million fine. The gaming giant administers GoldenPalace.com, one of the largest Internet casinos in the world.

McCarthy Tétrault Notes:

It is important to note that CWG’s conviction of illegal gambling resulted from a guilty plea. Police and court records suggest that the Crown and the company agreed to the payment of a fine rather than going to trial.

Though it is difficult to find information concerning the operation of the Golden Palace gaming site, it appears that the operator uses servers and call rooms located on the Kahnawake Mohawk reserve and that the site is licensed by the Kahnawake Gaming Commission.

If no activity related to the gaming website takes place anywhere in Canada other than Kahnawake, a criminal trial would have raised a number of highly political issues about the status of Kahnawake as an independent nation and its right to host and license gaming websites.

Under the Criminal Code, only provincial governments are authorized to license gaming activities in Canada. However, the Mohawks assert a right to issue gaming licences under Sec. 35 of the Constitution Act. To date, their authority to do so has never been settled in court.

The court would also have had to deal with a significant number of major legal issues concerning the nature of online gaming. For example, it would be necessary for the Crown to prove that allowing Canadians to gamble in an online casino that is (arguably) operated entirely outside of Canada constitutes a criminal activity.

It appears that neither party was sufficiently sure of its position on any of these issues to risk going to trial. Apparently, the simpler and more effective approach was to agree to a relatively large fine. That way, the Crown did not have to prove its case, and the company’s executives were spared possible jail terms.

It is also probable that CWG agreed to close its office in St. Laurent and move entirely offshore, removing the problem entirely from the purview of the Québec authorities. To date, Golden Palace continues to permit Canadians to gamble on its website.

Contact: Danielle M. Bush in Toronto at [email protected]



Québec: Bill 48 — Recent Amendments to the Québec Consumer Protection Act

In Volume 3, Issue 1 of the TLQ, we provided an overview of recent amendments to the Québec Consumer Protection Act that deal with arbitration clauses in consumer contracts, as well as ‘distance contracts’ with consumers (e.g., contracts formed over the Internet).

The distance contracts provisions are based on the Internet Sales Contract Harmonization Template and impose significant information obligations on merchants. Since those provisions came into force on December 15, 2007, all businesses carrying on business in Québec and entering into contractual relations with consumers — whether by fax, e-mail, telephone or the Internet — must ensure that their contract formation practices comply with the new requirements.

On the same date, the Québec government adopted regulations under the Act that exempt certain types of distance contracts from some of the writing, paper, ‘duplicate copy’ and signature requirements in the Act. These include, notably, contracts of credit and contracts of service involving sequential performance.


The new regulations remove a significant barrier to certain forms of e-commerce in Québec. The ‘paper’ requirements, for example, had previously made it impossible for businesses and financial institutions in

Québec to enter into contracts of credit with consumers over the Internet. In this sense, the regulations promote the principle of technological neutrality and serve to harmonize the regulatory regime in Québec with the regimes applicable in other provinces.

Contact: Charles S. Morgan in Montréal at [email protected]



SOFTWARE LICENSING

International: Open Source Software and Open Content Licensing: From Copyright to Copyleft — Part II

This article is the second in a four-part series focusing on open content licensing, the copyleft regime under Version 2 of the GNU General Public License (GPL), challenges pertaining to governing law, safe harbour provisions and other practical legal concerns with the GNU GPL, including some thoughts on the recently released Version 3.


The open source problem most frequently encountered by intellectual property practitioners involves situations in which a seemingly proprietary software product has elements of copyleft open source software incorporated into it, either inadvertently or by design.

The ensuing risk is a total loss of the proprietary nature of the product in question, given the consequential application of the copyleft provisions of the open source license to the combined work as a whole that is based, in whatever way, upon the open source software. Thus, what was once thought to be an exclusive and valuable asset in the hands of the copyright owner becomes subject to an obligation to release associated source code to members of the public.

The particular challenges associated with copyleft open source licensing, as discussed in the first part of this series, are increasingly arising in the context of technology asset acquisitions and share purchase transactions involving technology businesses.

Where the motivations behind these acquisitions and transactions focus on gaining a market advantage based on the exclusive nature of an important intellectual property asset, it is not difficult to understand how improper or unexpected open source software utilization can lead to a readjustment of transactional or asset pricing, or even to the abandonment of the intended acquisitions or purchases in question.

This article advocates a two-stage analysis for determining whether a particular utilization of open source code, that is licensed under the GNU GPL, will trigger the imposition of copyleft obligations on a resulting work that incorporates all or a part of the originating open source material:

1. One must determine whether the utilization of the licensed open source code, whether by way of incorporation, modification or adaptation, constitutes an actionable infringement of copyright under the relevant law.

2. One must then determine whether the prima facie actionable activity is otherwise made permissible by any safe


harbour provisions that may be found in the provisions of the GNU GPL itself, in the language of its associated Frequently Asked Questions as published by the Free Software Foundation, or in any other authorizing and binding pronouncement made by or on behalf of the owners of the copyright which subsists in the originating open source material (as explained in greater detail below).

The copyleft provision of the GNU GPL is found at Section 2 of the license according to the following language, reproduced in relevant part:

2. You may modify your copy or copies of the Program or any portion of it, thus forming a work based on the Program, and copy and distribute such modifications or work … , provided that you also meet all of these conditions:

[…]

b) You must cause any work that you distribute or publish, that in whole or in part contains or is derived from the Program or any part thereof, to be licensed as a whole at no charge to all third parties under the terms of this License.

[…]

These requirements apply to the modified work as a whole. If identifiable sections of that work are

not derived from the Program, and can be reasonably considered independent and separate works in themselves, then this License, and its terms, do not apply to those sections when you distribute them as separate works. But when you distribute the same sections as part of a whole which is a work based on the Program, the distribution of the whole must be on the terms of this License, whose permission for other licensees extend to the entire whole, and thus to each and every part regardless of who wrote it.

Thus, it is not the intent of this section to claim rights or contest your rights to work written entirely by you; rather, the intent is to exercise the right to control the distribution of derivative or collective works based on the Program.

In addition, mere aggregation of another work not based on the Program with the Program (or with a work based on the Program) on a volume of a storage or distribution medium does not bring the other work under the scope of this License. (emphasis added)

Section 3 of the license contains the requirement to distribute the corresponding source code for software works within the scope of the GNU GPL.

Section 2 of the GNU GPL as reproduced above refers to the defined term “Program,” which in Section 0 of the License is defined as “any program or other


work which contains a notice placed by the copyright holder saying it may be distributed under the terms of this General Public License.”

The copyleft requirement of having to distribute derivatives of the licensed work under the terms of the GNU GPL is based in part on the notion of “a work based on the Program,” as found in the opening language of Section 2. This expression is also itself defined in Section 0, which refers to “a work containing the Program or any portion of it, either verbatim or with modifications and/or translated into another language.”

While the opening language of Section 2 of the GNU GPL makes use of this defined expression, and the closing text of the section also reverts to it, the operative language of subsection 2(b) of the provision instead refers to a somewhat different expression, namely a work “that in whole or in part contains or is derived from the Program or any part thereof.” Other areas of Section 2 explain as a statement of intent that the provision seeks to control the distribution of “derivative or collective works based on the Program.”

Sorting out these inconsistencies of language will result in an identification of works that are caught at first instance by the scope of Section 2 of the GNU GPL, and that are therefore prima facie subjected to the copyleft requirements of the license.

Works Subjected to Copyleft Obligations at First Instance

Despite the use of different key expressions within the language of Section 2, one can venture to say that all of these expressions produce a common thread that suggests the copyleft effect of the GNU GPL applies at first instance to any work constituting a reproduction of the licensed work as ordinarily prohibited by copyright law. This may include a verbatim copy of the licensed work, or a copy of same containing modifications or enhancements, or a new work that incorporates the licensed work, all in a manner that would otherwise constitute an infringement of copyright under applicable law.

All of these examples would be consonant with any of the types of works described in Section 2 of the GNU GPL, whether as “a work based on the Program,” or as “a work that in whole or in part contains or is derived from the Program or any part thereof,” or as “derivative or collective works based on the Program.”

The interpretive reference to the latter expression in Section 2 can moreover be viewed as reinforcing the notion that the license is intended to circumscribe conduct in relation to the licensed materials only to the extent that such conduct is otherwise infringing. This also falls very squarely within the traditional understanding of licensing as held by intellectual property


practitioners, namely that a license authorizes conduct that would otherwise be unlawful.

Section 3(1) of the Canadian Copyright Act defines those acts reserved to the exclusive privilege of the copyright owner as including “the sole right to produce or reproduce the work or any substantial part thereof in any material form whatever.” The same section of the statute goes on to list further specific acts falling within the purview of the exclusive rights attaching to copyright. Section 27(1) of the Act defines infringement as “anything that by this Act only the owner of the copyright has the right to do.”

While the Canadian statute does not per se define a concept of “derivative works” as that expression is employed in Section 2 of the GNU GPL, the Supreme Court of Canada has likened the exercise of the reproduction right to the creation of derivative works. In Théberge v. Galerie d’Art du Petit Champlain inc., the majority of the Supreme Court held that the result of lifting an ink layer in respect of an artistic work rendered on a paper substrate and its transposition to a new canvas substrate did not constitute an infringement of copyright. In so doing, the court made the following pronouncements regarding derivative works under Canadian copyright law, through the majority reasons of Mr. Justice Binnie:

The concept of a derivative work is found in the Berne Convention, and in the copyright legislation of the

United States, England, Australia, New Zealand and Canada. All these provisions reflect a common progression in copyright legislation from a narrow protection against mere literal copying to a broader view which allows the copyright owner control over some changes of medium or adaptations of the original work. While the idea of “derivative works” therefore has parallels in other jurisdictions, including Canada, the American statutory language is particularly expansive, including in particular the words “any other form in which a work may be recast, transformed, or adapted,” that have no precise counterpart in Canadian legislation.

I should note that while there is no explicit and independent concept of “derivative work” in our Act, the words “produce or reproduce the work … in any material form whatever” in Sec. 3(1) confers on artists and authors the exclusive right to control the preparation of derivative works …

Elsewhere in the majority reasons, Mr. Justice Binnie indicated that examples of derivative works are found in Sections 3(1)(a) to (e) of the Canadian statute. All are consistent with the notion of a reproduction, as they imply the creation of new copies or manifestations of an underlying work.


Section 2 of the GNU GPL also refers to the term “collective works.” Unlike the expression “derivative works,” collective works are expressly defined in Section 2 of the Canadian statute to mean “(a) an encyclopedia, dictionary, year book or similar work; (b) a newspaper, review, magazine or similar periodical; and (c) any work written in distinct parts by different authors, or in which works or parts of works of different authors are incorporated.”

In the Supreme Court of Canada decision in Robertson v. Thomson Corp., the majority of the court found that the reproduction and republication in an online database of articles sold by a freelance writer to a newspaper publisher constituted an infringement of the writer’s copyright in the article.

According to the reasons of Justices LeBel and Fish, the articles in question had been decontextualized to a point that they were no longer presented in a manner that maintained their intimate connection with the rest of the newspaper. As such, the republication activity fell outside the newspaper publisher’s rightful entitlement to produce or reproduce the articles as part of a collective work.

Based on this reasoning, a collective work under Canadian law presumably involves the incorporation of the works of multiple authors into a single work, where those works are contextualized or otherwise intimately connected with one another while remaining separate and distinct.

The foregoing characterization of which particular works are subject to the copyleft regime of the GNU GPL requires an infringement analysis under applicable governing law. This, of course, begs the question of what that governing law would or should be in the context of the GNU GPL. This question will be discussed in Part III of this series.

Contact: Alfred A. Macchione in Toronto at [email protected]



Technology Finance

TECH-RELATED FINANCE

North America: Taking Your Tech Company Public — Part II

In the last issue, we considered some reasons why private tech companies might want to go public. (Going public is the process of issuing shares to the public pursuant to a prospectus, a document that provides significant disclosure about the financial and other aspects of the company.) But founders and shareholders of private companies should consider the cons as well as the pros of being a public company. Therefore, before turning to the legal process involved in going public, this article focuses on some of the downsides of being a public company.

Losing Control

In many private companies, the founder (or founders) of the company is still the principal shareholder. As such, the founder more or less runs the company the way he or she wants to. For instance, the founder may choose to focus on long-term prospects and make investments that depress earnings in the short term, but that increase the chances for longer-term profitability.

Public companies, by contrast, tend to operate on fairly short quarterly time horizons. Most investors track quarterly earnings of public companies. If these results do not match

expectations, many investors will often sell the stock, putting downward pressure on its share price. For public companies, closing business at the end of each quarter then becomes an extremely important exercise so earnings estimates can be met or exceeded.

Thus, a founder who takes public his or her previously private company may well come to feel that he or she has lost control of its destiny, and that as a public company, the requirements of the stock market have taken over. Some founders believe this is a trade-off worth making. Other founders, particularly in the tech space, leave the public company and start over again with another tech startup.

Another dynamic of the public company that can give a sense of a loss of control is, as the name suggests, the lack of confidentiality for public companies. In the next issue, we’ll see just how revealing the company’s prospectus is (as it should be, in a securities law context). And then all the material information in the prospectus is periodically updated so that the investing public can keep tabs on the company. This all makes perfect sense. It’s just that some tech entrepreneurs are not ready for it, and their expectations around loss of control have to be managed.

A founder’s sense of loss of control can be mitigated somewhat if the tech company has obtained venture capital financing while it was still a private company. In that case, the founder will have had representatives of the


investors on the company’s board of directors, and would have provided investors with regular financial information. Therefore, founders who have gone through one or two rounds of venture investment tend to find the transition to a public company easier than those who have not done so.

Toward Board Independence

Another way in which a founder can lose control of his or her previously private company after it has gone public is through the board of directors. In a private company, the founder essentially appoints all the members of the board and they serve at his or her pleasure (unless the private company had some venture investors, as noted).

With a public company, the law typically provides that a certain percentage of the board members must be independent; that is, they cannot have a connection to the company or the founder that would compromise their independence. Moreover, the agencies that regulate public companies (so-called securities regulators) are advocating that the majority of directors on a public company board be independent. This allows the board to more independently oversee the management team, and often, to challenge management on some very fundamental strategies and tactical issues confronting the company.

Independent Board Committees

If public company boards are increasingly moving toward independence, the audit committee of the board is already there.

The audit committee members of the board oversee the company’s interactions with its external auditors. They also oversee the internal financial controls of the company, as well as its risk-management procedures. By law, all members of the audit committee must be independent.

Similarly, the board’s compensation committee is composed of either entirely independent directors, or at least a majority of them. Again, the upshot for the founder is that his or her discretion in both the longer-term strategic and shorter-term tactical decisions for the company will be increasingly fettered. The objective is now to achieve better corporate decisions through independent analysis and input. Nonetheless, the result for the founder is less room to manoeuvre than what was the case as a private company.

Unwanted Sale of the Company

In many cases, within a year or two of going public, the founder will sell sufficient shares of the company such that he or she no longer retains a majority. This typically means the founder has done well financially by virtue of the initial public offering (IPO), but it does raise the spectre of the founder eventually losing ownership control of the company altogether.

This is so because once the shareholdings of the founder fall below a certain percentage, the company is susceptible to a takeover bid from another company or one or more investors. In such cases, the buyers usually only have to convince the holders of a majority of


the company’s shares to sell into their offer, and they can then become the new owners. Many founders have been ousted from the companies they founded and took public, much to their dismay. But that possibility goes with the territory when the founder takes the company public.

A Public Company Candidate?

Even before considering the issues surrounding control — and the concerns the founder might have about losing it — one must ask if the company is even a good candidate for the public markets. As noted, steady quarter-to-quarter earnings performance is vastly important in the public securities markets. Therefore, companies with healthy sales and even robust growth — two requirements for public company success — might still be problematic if their sales, on a quarterly basis, are lumpy or cyclical. A couple of bad quarters can greatly devalue the company’s share price and cause a significant decline in the net worth of the founder (assuming much of it is tied up in shares of the company). And it might take years for the share price to recover.

Another issue revolves around the senior management team required for a public company. In a tech company, the founder may have superior science-related skills and might be the enterprise’s technology guru. And as a private company, this may still be the critical skill set of the management team. But in a public company, a CEO’s ability to generate and hold the confidence of the investor community is probably of paramount importance. Thus, many sensible founders

change their public titles following the IPO and bring in seasoned senior management — such as a new CEO and CFO — to take the public company to the next level. However, many founders have not done this, or have not done this well — and have devalued their companies as a result.

Once the founder has thought through the various issues noted above, and the decision is made to proceed with an IPO, then the exercise turns to the nuts and bolts of going public through the prospectus process. We will discuss this topic in the next issue.

Contact: George S. Takach in Toronto at [email protected]



Ontario: Venture Capital Developments

Ontario Government Announces Establishment of Venture Capital Fund

In November 2007, the Ontario government announced it had entered into a letter of intent with Canadian institutional investors to establish an Ontario-focused venture capital ‘fund of funds.’ This is part of the government’s stated goal to “strengthen Ontario’s ability to support innovative, high-growth companies in the province to expand business opportunities and create jobs.”

Ontario will commit $90 million to the fund and the other investors — OMERS Administration Corporation, Business Development Bank of Canada, RBC Capital Partners and Manulife Financial — will together commit $75 million, for a total of $165 million for the first closing of the fund.

This announcement was only the first step in putting to work the $90 million in government venture capital funding initially earmarked in the March 2006 Ontario budget. It is expected that the Ontario government and the initial investors will select an institutional fund of funds manager early in 2008, and that following an initial closing, the fund will begin operations. The government also seeks additional institutional investors for subsequent closings and hopes to bring the total fund size to at least $250 million.

This new fund’s impact on Ontario-based entrepreneurs will be primarily indirect.

The fund will instead make commitments to venture capital funds with some focus on Ontario, which in turn will make investments in entrepreneurial businesses. The fund of funds manager will establish criteria for making such commitments. A significant portion of this capital is expected to be committed to well-established Canadian venture capital fund managers. Some funds, however, may also be committed to emerging fund managers or possibly foreign venture capital funds, provided they can demonstrate an appropriate degree of association with Ontario. Further details of the fund are to be determined.

Ontario Government Extends Phase-Out of Tax Credits for Labour-Sponsored Investment Funds

In 2005, the Ontario government announced it would end the provincial tax credit for labour-sponsored investment funds (LSIFs). Then, in consultation with the LSIF industry, the government established a phase-out of the LSIF tax credit over a number of years. The timetable of the phase-out allows investors who purchase LSIF shares to receive a provincial tax credit until the end of the 2010 tax year.

In December 2007, the government announced a proposal to extend the phase-out by one year. If implemented as proposed, the phase-out would work as follows:

• Tax credits would continue at a 15 per cent rate until the end of the 2009 tax year.

• Tax credits for the 2010 tax year would be at 10 per cent.


• Tax credits for the 2011 tax year would be at five per cent.

For tax years after 2011, there would no provincial tax credits for investment in LSIF shares (federal tax credits of 15 per cent remain untouched at this time). As part of the same announcement, the government also proposed increasing the maximum investment in LSIFs that qualify for the provincial tax credit from $5,000 to $7,500.

With these changes, the Ontario government estimates an additional $38 million will be committed indirectly to the development of entrepreneurial businesses in Ontario over the three years affected by the proposal.


The launch of the Ontario venture capital fund and the extension of the tax credit phase-out on LSIF funds come at a time when many industry watchers are sounding alarm bells over the lack of venture capital funding available in Canada in general and in Ontario in particular. While venture capital investment has been strong in the US and elsewhere, it appears the venture capital market in Canada has been stagnant or shrinking.

For example, a recent report by Deloitte noted that for the third quarter of 2007, approximately $517 million venture capital dollars were invested in Canadian operating companies. This is down from $653 million for the same period in 2002, roughly a 21 per cent drop over five years. Almost

one-third fewer Canadian operating companies received venture capital funding over that period.

The same report notes that total funds raised by Canadian venture capital firms also declined significantly over the same period. Just shy of $3.1 billion was raised in 2002, but just over $1.6 billion was raised in 2006. To the end of the third quarter in 2007, only $852 million had been raised. Some blame much of this decline in funding on the Ontario government’s original decision in 2005 to phase out its tax credits on LSIFs.

The situation might be more harrowing if not for another significant trend: the increasing role played by foreign venture capitalists in our domestic market, particularly those from Boston and Silicon Valley. Recently announced statistics of the CVCA, Canada’s Private Equity and Venture Capital Association, noted that venture investment activity across Canada had grown in 2007 as compared to 2006, but much of the increase has been due to US-based venture funds seeking investment opportunities in Canada. Through the third quarter of 2007, foreign firms represented more than 55 per cent of all venture capital dollars invested in Ontario. The influence of non-Canadian firms in other provinces (32 per cent in Québec and 29 per cent in B.C.), while not quite as dramatic, is still significant.

Even those entrepreneurs able to attract attention from south of the border have


challenges. Current Canadian tax laws create barriers to efficient cross-border investment by US-based venture capital funds. If a US-based fund directly invests in a Canadian operating company, on disposition it will generally be required to obtain a Section 116 certificate from the Canada Revenue Agency, file a tax return and provide certain other details regarding each of its limited partners. However, a US-based venture capital fund may be precluded from doing so under its limited partnership agreement.

To steer clear of these administrative burdens, many US venture funds have resorted to structuring their investments in Canada through an exchangeable share transaction. These funds invest directly in a newly established Delaware company into which all of the shares of the existing Canadian operating company are exchangeable upon certain events occurring.

Other US funds have been known to structure their investments in Canada through a third jurisdiction that may be more favourable from a tax-planning standpoint, such as Barbados or Luxembourg. Each of these options, however, can add substantial time and cost to the venture capital investment transaction.

In the end, these announcements by the Ontario government — to create a new government-sponsored venture capital fund and extend the tax credits on LSIF funds — are certainly good news. The new venture

capital fund will be a welcome addition to the sources of capital (albeit indirect) for Ontario-based entrepreneurs. Nevertheless, these measures represent only a small start in addressing the venture capital funding gap in Ontario. Greater effort by both government and industry is required.

Contact: W. Ian Palm in Toronto at [email protected]



Technology Contracting

OUTSOURCING

International: Offshore Business Process Outsourcing 101 — Part I

This article begins a three-part series focusing on the basics of offshore business process outsourcing (BPO). Part I explores business trends and strategies in offshore BPO from a legal perspective. Part II discusses certain key legal considerations that arise in offshore BPO transactions. Part III examines the ongoing relationship between a company and its outsourcing vendor after the offshore BPO transaction has been consummated.

To BPO or Not to BPO

Generally speaking, BPO is the outsourcing of an organization’s internal functions or operations to a service provider. BPO should be distinguished from the outsourcing of a company’s information technology (IT) operations, though BPO usually has an IT element.

Commonly outsourced business processes include call centres (e.g., customer care and help desk), finance and accounting (e.g., accounts receivable and general ledger reconciliation), item processing (e.g., data entry and application processing) and human resources (e.g., payroll processing and benefits administration). Less commonly outsourced business processes include marketing, project

management, portfolio management, and research and development.

Given the ease and speed with which we can transmit data around the world today, it’s not difficult to come up with a long list of a company’s different internal operations that could be performed by a service provider in another country.

In the late 1990s and the early part of this decade, many US and European conglomerates used their experience in offshoring IT operations as a springboard to begin sending some of their ‘commoditized’ business processes offshore, often as part of cost-cutting and ‘business transformation’ initiatives. Some industry analysts predict that the global offshore BPO market will surpass US$200 billion in 2008.

As the offshore BPO market has matured and Canadian companies and their regulators have become more comfortable with offshore BPO, the question of whether to BPO has become more complex. Even clear cost savings, to be realized by having inexpensive but highly educated labour process data beamed across the ocean, will be only one factor in the decision. The availability of properly qualified service personnel overseas, data security risks, varied intellectual property regimes, taxation issues and currency fluctuations — among many other factors — make offshore BPO one of the most challenging sourcing initiatives a company can undertake.


But first things first: You must start by defining what it is you plan to outsource.

You’re Outsourcing What?

The analysis of whether to offshore a business process must begin with the business process itself and what your company wants to do with it. A company may simply want to duplicate a process it currently runs onshore. Often referred to as a ‘lift and shift’ in outsourcing parlance, the goal here is maintaining the status quo and realizing the benefits of labour arbitrage. Often, the company will continue to run the same process onshore in parallel and let the onshore operations define the outsourced business processes and the levels at which they are performed.

A company may also send business processes to an outsourcing vendor with the objective of improving the company’s operations or even completely revamping them. This scenario may be referred to as ‘continuous improvement’ or ‘business transformation.’ Whatever you call it, the goal is to harness the vendor’s expertise at making the business process more efficient, productive and cost-effective. As Part II of this article will explore in greater detail, this approach could have significant intellectual property implications.

Before outsourcing a business process, a company must take a hard look at what it is trying to accomplish. Chances are, the business process you have in mind can be performed by a third party, but outsourcing won’t be worthwhile if the process can’t be performed

offshore at the same level or better at a substantially lower cost. If the outsourcing vendor is expected to transform the way the business process is performed, the contractual arrangement must clearly define how this is to be accomplished.

Looking Inward before Outsourcing

A company must get a handle on what it does in-house before expecting an outsourcing vendor to take over a business process. As noted, documenting as accurately as possible the functions that the vendor will perform is critical. If your company has never written down exactly what its personnel do all day (let alone some numerical representations of the level at which they must perform), this task can be time-consuming and should be done before you speak with any vendors.

Many companies find it worthwhile to hire outside consultants to help them examine internal practices and recast them as arm’s-length service commitments for the chosen outsourcing vendor. These commitments — usually called ‘service levels’ — are most effective when they are stated in simple, objective (often mathematical) terms and reflect a cross-section of the most important elements of your operations. To the extent your company expects the outsourcing vendor to improve upon your company’s past performance, these service levels will serve as a useful baseline against which the vendor’s ongoing performance and future improvements can be measured.


Taking a Measured Approach

Now that you have considered the fundamental question of whether to outsource, you must consider how much. Outsourcing is rarely an all-or-nothing proposition. Depending on your company’s goals along the spectrum between cost savings and quality of service, it may make sense to keep a material portion of the outsourced business process running onshore.

Or, it may be to your advantage to split the work between two vendors. The two-vendor solution will force competition and potentially lead to better terms and pricing. However, managing two vendors can be unwieldy and may diminish the economies of scale that you could potentially realize by sticking with a single vendor.

Creating a Market with Competitive Bidding

Experience tells us the most effective way to maintain real negotiating leverage with a prospective outsourcing vendor is to make it compete for the business. A multi-vendor bidding process followed by dual-track negotiations frequently results in a more favourable arrangement for the outsourcing customer than engaging a vendor in one-on-one negotiations.

The competitive process creates a ‘market’ for pricing, as well as the terms and conditions in the outsourcing agreement. While the competitive bidding process is time-and resource-consuming, the added cost of undertaking this process is often more than

offset by the reduced pricing and lower legal risk to which the winning bidder agrees.

On that note, make sure it is understood (and documented in an outsourcing contract) that terms bid by the winning vendor are locked in for the duration of the negotiation while other details are settled. And beware the vendor who underbids the work on the front end and then attempts to squeeze more money out of your company after the competition has left the building.

It’s about the People

In BPO, the focus of the transaction is often on the people performing the services, though technology plays an important role. Whether the outsourced business process is a call centre or an accounting function, the vendor’s employees must have the requisite skills to perform the process as well as your company performs it onshore, or better.

Your outsourcing agreement should contain minimum standards that the vendor’s personnel must meet. It should also specify what the vendor must do to meet them. These may include the successful completion of criminal or financial background checks on the vendor’s personnel — particularly those who may have access to sensitive data such as your customer information — as well as minimum professional qualifications for these personnel. Companies often have a hand in training their outsourcing vendor’s personnel, and will sometimes stay involved until they are satisfied the vendor’s own trainers are competent at conducting the training themselves.


A BPO vendor’s profits are highly dependent on efficient hiring, management and scheduling of its resources. This practice may conflict with your company’s interests in maintaining high service quality, managing volume fluctuations and ensuring a good work environment among the vendor’s personnel. Consider whether you want contractual assurances from the vendor that certain resources will be dedicated to your processes and that the vendor will keep the use of overtime below a designated threshold.

As the labour pool in foreign markets becomes tighter, anything you can do to prevent resource ‘burnout’ and high turnover will help the overall quality of the services. It will also improve morale and increase your goodwill among the vendor’s resources.

Offshoring business processes effectively and maintaining business objectives take a concerted effort among the company’s many different subject matter experts, in-house counsel and often outside advisors.

In the next issue, we will survey some legal pitfalls in offshore BPO transactions and how a company’s sourcing team must coordinate its skills and objectives to navigate them.

Contact: Joel Ramsey in Toronto at [email protected]



Intellectual Property

COPYRIGHT

Canada: Sookman Responds to Geist

Copyright reform in Canada has long been the subject of lively and ongoing debate. Michael Geist, professor of law at the University of Ottawa, has written a series of editorials and blog posts criticizing the US Digital Millennium Copyright Act (DMCA) and claiming that the new Canadian copyright legislation will likely be modeled after it. He also established a group on Facebook, Fair Copyright for Canada, which quickly amassed over 12,000 members. When a copyright bill was not tabled by the federal government in December as had been expected, it was suggested that the bill was delayed due to a groundswell of opposition, much of it stemming from Prof. Geist’s efforts.

Barry Sookman, co-chair of the Technology Group at McCarthy Tétrault, has authored articles in which he seeks to provide a fuller and more balanced picture of copyright reform, clear up some of the public misconceptions on the Facebook site, and challenge certain assertions in Prof. Geist’s blog posts. The issues discussed in Sookman’s articles include the impact of the DMCA, the level of adoption of WIPO treaties in other countries, the level of consultation about copyright reform, the impact of P2P file sharing on rights holders, and the process to effect legislative change.

Contact: Barry B. Sookman in Toronto at [email protected]

International: WTO Challenge to China’s Intellectual Property Protection Regime

On September 25, 2007, the Dispute Settlement Body of the World Trade Organization (WTO) established a panel to review China's measures concerning the protection and enforcement of intellectual property (IP) rights, including trademarks and copyright.

The initial complaint was filed by the United States and Canada will likely be a third party to this proceeding. The United States claims that Chinese IP laws violate the WTO Agreements as follows:

• The thresholds that must be met in order for trademark counterfeiting and copyright piracy to be subject to criminal procedures and penalties are too high. That is, there is a lack of criminal procedures and penalties for commercial scale counterfeiting and piracy in China as a result of these high thresholds.

• Infringing goods confiscated by Chinese customs authorities are often released into channels of commerce (and exported abroad), instead of being destroyed.



• Authors of works whose publication/ distribution has not been authorized appear not to enjoy the minimum standards of protection specially granted by the Berne Convention.

• Pre-distribution and pre-authorization review processes for Chinese nationals' works, performances and sound recordings differ from the processes that apply to foreign nationals' works, performances and sound recordings, resulting in earlier or otherwise more favourable protection or enforcement of copyright rights for Chinese authors' works.

Canada is expected to participate in the proceedings in light of its interest in ensuring that Chinese IP laws are WTO-consistent. It is also seeking to curb the flow of infringing goods from China into Canada, many of which are subsequently shipped to the United States.

Contact: John W. Boscariol in Toronto at [email protected] or Brenda C. Swick in Ottawa at [email protected]

PATENTS

Canada: Top 15 Tips for Protecting and Enhancing Your Intangible Assets

Intangible business assets currently account for 70 to 85 per cent of the total value of business assets. With such significant value, does your business have a strategy to protect and enhance its intangible assets? If not, and you don’t know where to start, here are a few tips and suggestions:

1. Write down an intellectual property (IP) strategy, even if it is a few bullet points on a single page. This would include strategies around things such as brand, information (including personal and confidential information) and developments. Ideally, any material intangible asset in your organization should be covered by the strategy.

2. Align your IP strategy with your business plan and your business processes. It is amazing how often they don't line up. A key part of this alignment is getting senior level buy-in.

3. Inventory the types of intangible assets you have (e.g., existing and proposed products, brands, customer lists, processes and software). You'll be surprised at what you find.

4. When you acquire intangible assets, make sure that you (a) get enough rights to use the assets, even if your business model




changes (e.g., privacy consents, scope of use and affiliates); and (b) don't take on more risks than you intend to.

5. Communicate your IP strategy to your people. Not once, but on a regular basis. You need to create a culture where intangible assets are valued. Training is often more valuable than the words in the policy.

6. Develop processes to ‘capture’ intangible assets arising from your business. Don't let those assets drift out your door.

7. Avoid ‘jointly’ holding intangible assets with someone else, when possible. Otherwise, you will probably get more trouble than you bargained for.

8. Think carefully about your business processes, physical security and other mundane things (e.g., what happens to old computers in your organization?). Don't just focus on the legal side.

9. Get written IP assignments from your employees and contractors. You may be surprised at what they can own if you don’t.

10. If you can’t do it all internally, get help. There is too much at stake to simply give up or ignore it.

11. Don’t forget that significant portions of the intangible value are tied to people. Are you capturing knowledge and information from your staff? Do you

have plans in place to keep key people? What happens if key people leave?

12. Watch out for ‘open source’ software. Nothing in this world comes free.

13. Don’t assume the rest of the world works the way Canada does. Even our neighbour to the south has some different rules surrounding intangible assets.

14. Avoid restrictive provisions in agreements (e.g., noncompetes, restrictive covenants and confidentiality provisions). If you do sign an agreement that includes a restriction, keep track of it (e.g., keep a list).

15. Avoid vague or unclear language in agreements involving intangible assets. If it is not crystal clear to you when you sign the agreement, it probably will not get any better with age.

Contact: Matthew D. Peters in Vancouver at [email protected]



Privacy

CASES/LEGAL DEVELOPMENTS

Canada: Privacy Commissioners Rule on High-Profile Privacy Breach

The federal and Alberta privacy commissioners have jointly issued a report criticizing certain retail industry companies for failing to implement adequate security safeguards for customer information, resulting in privacy breaches. The commissioners were particularly concerned that the companies had (i) collected too much personal information that was not required for business purposes, (ii) used retention periods that were too long, and (iii) relied on weak encryption technology. In addition to being a good example of the need for appropriate security standards, the following case is also a caution against collecting more information than is necessary for transactions and retaining the information indefinitely.


In January 2007, TJX Companies, Inc., the parent company to Winners Merchants Inc. and HomeSense in Canada, issued a press release to announce that it had suffered an unauthorized intrusion into its computer systems that process and store information related to customer transactions. The company stated that the intrusion involved the portion of TJX’s computer network that handled credit card, debit card, cheque

and merchandise return transactions for customers. The company had alerted law enforcement authorities of the crime, and with the authorities’ agreement, had notified its contracting banks, credit card, debit card and cheque-processing companies of the suspected intrusion.

Later that month, the Privacy Commissioner of Canada and the Information and Privacy Commissioner of Alberta announced they would jointly investigate the database breach and how it affected Canadians who shopped at Winners and HomeSense. The joint report was issued in September 2007.

The commissioners said the breach involved millions of credit and debit card numbers, as well as other personal information such as driver’s licence numbers and addresses collected when customers returned merchandise without receipts. TJX believed that the intruder initially gained access to customer information via the wireless local area networks at two of its stores in the United States and the information was stolen from mid-2005 through December 2006.

The commissioners’ investigation found that:

• TJX did not properly manage the risk of an intrusion against the amount of customer data that it collected;


• the company failed to act quickly in converting from a weak encryption standard to a stronger standard;

• TJX did not meet its duty to monitor its computer systems vigorously; and

• the company did not adhere to the requirements of the Payment Card Industry Data Security Standard, which was developed to address the growing problem of credit card data theft.

The companies collected driver’s licence and other identification numbers when unreceipted merchandise was returned as part of a fraud prevention process. While the commissioners agreed that the collection of some personal information from customers is acceptable when merchandise is returned without a receipt (including name and address), the collection of driver’s licence numbers was found to be not reasonable in the circumstances.

The company had confirmed that the refund-management system could operate with any unique numeric identifier, and did not require a driver’s licence or other provincial identification number. The commissioners suggested that a driver’s licence number was not intended to be an identifier for conducting analysis of shopping return habits, particularly as this number is an extremely valuable piece of data to fraudsters and identity thieves intent on creating false identification with valid information.

In addition, these key numbers were retained indefinitely. The commissioners felt this was inappropriate and stated that “organizations should collect only the minimum amount of information necessary for the stated purposes and retain it only for as long as necessary, while keeping it secure.” However, the commissioners ultimately accepted the proposal by the companies to temporarily keep driver’s licence information but convert it to a new ‘hash value’ number that would render the actual driver’s licence numbers unreadable.

The commissioners urged companies to be vigilant when safeguarding their information. More sensitive information should be safeguarded by a higher level of protection, which could include physical measures, such as locked filing cabinets and restricted office access; organizational measures, such as security clearances and “need to know” access; and technological measures, such as passwords and encryption. The commissioners emphasized that “once in place, security measures must be actively monitored, audited, tested and updated when necessary.”

After the release of the joint report, Winners and HomeSense announced that while the companies disagreed with many of the commissioners’ factual findings and legal conclusions, they had chosen to implement the commissioners’ recommendations, and had already implemented most of them. TJX advised


the commissioners that it would convert the driver’s licence number obtained as part of its returns policy into a unique identifying number when keyed into the point-of-sale system. The companies also plan to outfit all of their stores with new chip and PIN-capable pads and “expect to be among the first major Canadian retailers fully ready to accept the new, more secure chip and PIN payment cards.”

Prior to the release of the commissioners’ report, TJX had announced a proposed settlement of the customer class actions arising from the intrusions. The settlement is subject to court approval and other conditions.

Contact: Barbara A. McIsaac in Ottawa at [email protected] or Howard R. Fohr in Ottawa at [email protected]

Canada: Passport Office Suffers Privacy Breach

According to a Globe and Mail report on December 4, 2007, Passport Canada’s website contained a security flaw that allowed easy access by the public to sensitive personal information, including driver’s licence numbers, social insurance numbers and birth dates.

The nature of the breach was such that any individual completing his or her own passport application online could, by changing a single character in the URL, view another individual’s application.

Passport Canada has provided assurances that the online portal does not give access to the agency’s permanent database and that the information compromised was limited to the data of pending applications made online. Once a passport has been issued, the online information is removed.

The Office of the Privacy Commissioner of Canada, which was coincidentally auditing Passport Canada’s data management practices when the breach was discovered, added the breach to its audit, with findings to be released in the spring of 2008. The security breach has since been corrected.

Contact: Howard R. Fohr in Ottawa at [email protected]





Canada: Federal Government Introduces Criminal Law Reforms to Target Identity Theft

Identity theft is a growing concern, estimated to cost Canadian consumers, financial institutions and businesses more than $2 billion annually. To combat this problem, the federal government has introduced proposed amendments to the Criminal Code.

Currently, there are certain offences in the Criminal Code relating to the misuse of another person’s identity information, such as personation and forgery. However, the existing offences do not cover collecting, possessing and trafficking in identity information, which are preparatory steps to identity fraud. According to the government, these reforms will permit police to intervene at an earlier stage of the criminal operations, before identity fraud is attempted or committed.

Bill C-27 will make it an offence to:

1. obtain or possess identity information with the intention to use it to commit certain crimes such as fraud or forgery (Identity information is broadly defined to include “any information — including biological or physiological information — of a type that is commonly used alone or in combination with other information to identify or purport to identify an individual.” It encompasses name, address, date of birth, signature, credit card number, passport

number, health insurance number, driver’s licence number, fingerprint, voiceprint and DNA profile, as well as other information.);

2. traffic in identity information knowing or being reckless that such information will be used to commit certain crimes; or

3. unlawfully possess or traffic in government-issued identity documents such as social insurance numbers, driver's licences, health insurance cards, birth certificates and passports.

Each new offence carries a maximum five-year sentence. The legislation also allows the court to order an offender to reimburse the victim of identity theft or identity fraud for expenses incurred to re-establish the victim’s identity, including the cost of replacing identity documents and correcting credit history.


Identity theft is a mounting concern for clients and consumers in the wake of increasing instances of ‘phishing’ as well as massive data privacy breaches, whether through inadvertent data loss or through deliberate security intrusions.

The past year has seen several high-profile instances of data theft, the first step in a process that may lead to identity theft. McCarthy Tétrault has assisted a number of its clients with matters related to information security, as well as mitigation of loss following a privacy breach.


The proposed amendments to the Criminal Code serve to highlight the serious nature and high cost of identity theft, and will, it is hoped, reduce the frequency and scope of its occurrence.


Canada: eBay Canada Required to Provide Information on PowerSellers to Canada Revenue Agency

In a September 18, 2007 ruling, Justice Roger Hughes of the Federal Court of Canada affirmed that the Canada Revenue Agency (CRA) has the right to examine records on Canadians who generate monthly sales of more than US$1,000 through the online marketplace on eBay, also known as ‘PowerSellers.’

The judgment was a review of a November 6, 2006 order against eBay Canada Limited and eBay CS Vancouver Inc. requiring that they provide information to the Minister of National Revenue about the PowerSellers. The CRA sought information — including names, mailing and billing addresses, phone numbers, e-mail addresses and sales figures, in its investigation of whether individuals were reporting the income they had generated from sales in 2004 and 2005.

eBay Canada and eBay Vancouver contested the order, claiming they did not own or possess in Canada any information regarding these sellers. Specifically, the Canadian eBay entities argued that all information related to users’ sales transactions was stored electronically on computer servers located in the US, and was owned and under the control of eBay Inc., a US corporation and the ultimate parent company.

The key issue in this case was whether Section 231.2 of the Income Tax Act permits an order requiring a Canadian resident to provide information to which it has access in Canada,



but that is stored in data facilities owned by another party outside of Canada.

Though Justice Hughes agreed that this information is not ‘owned’ or controlled by eBay Canada, he found that eBay Canada has access to this information and, more importantly, accesses and uses it in the course of its business operations in Canada. The location of the servers is irrelevant. In today’s world, electronic information “cannot truly be said to ‘reside’ in only one place or be ‘owned’ by only one person. The reality is that the information is readily and instantaneously available to those within the group of eBay entities in a variety of places.”

It should be noted that this case is continuing. The issue of whether the CRA has provided sufficient evidence to demonstrate it is carrying out a “genuine and serious” inquiry is still to be addressed.


As this case may require businesses to provide customer information to CRA in certain instances, it could have important implications for businesses and their customers. Information concerning Canadian clients that can be accessed and used by an online commercial enterprise in Canada appears to be fair game regardless of where the information is stored or who asserts ownership over it.

Contact: Joel Ramsey in Toronto at [email protected] or Howard R. Fohr in Ottawa at [email protected]

US: A New Trend in Liability for Security Breaches?

In the wake of the high-profile security breach that occurred at TJX Companies, Inc., affecting more than 46 million credit and debit card holders in several countries including the US and Canada, financial institutions have been lobbying for legislation to shift the financial risk associated with such breaches to retailers.

The Minnesota Law

As a result of these efforts, in May 2007, Minnesota became the first state to pass legislation making retailers and other merchants liable to banks for costs associated with data breaches. Under the new Minnesota law, as of August 1, 2007, any “person or entity conducting business in Minnesota” that accepts credit or debit card payments as part of such activities is prohibited from retaining credit or debit card security data of Minnesota residents after the authorization of the transaction.

The Minnesota act defines credit or debit card security data as the “card security code data, the PIN verification code number, or the full contents of any track of magnetic stripe data.”




As of August 1, 2008, a financial institution may sue a company, if it has retained such prohibited information after an authorization and a security breach occurs (regardless of where the breach occurs), to recover “the cost of reasonable actions undertaken” in response.

A security breach is defined as the unauthorized acquisition of computerized data that compromises the security, confidentiality or integrity of personal information maintained by the person or business.

The legislation provides that recoverable costs include:

• costs related to providing cardholders with notification of the breach;

• costs incurred in cancelling and reissuing cards;

• costs associated with the closing or reopening of accounts and with any steps taken to stop payments or block payments on accounts;

• refunds paid to cardholders in respect of unauthorized transactions charged to their accounts; and

• damages paid by the financial institution to cardholders as a result of the security breach.


The Minnesota legislation establishes a strict liability standard on retailers. As a result, this legislation will effectively

supersede the allocation of risk arising out of security breaches that is frequently negotiated between payment processors and their merchants as part of the payment-processing agreement, and that is also established between the payment processors and credit card associations such as Visa and MasterCard.

For example, agreements between the payment processor and the merchant may require the merchant to comply with the Payment Card Industry Data Security Standards (the PCI DSS), and assign liability to the merchant for a security breach if the merchant has failed to do so. Under the Minnesota legislation, however, the merchant is exposed to liability even if it has complied with the PCI DSS.

Businesses far beyond Minnesota could be affected by the legislation, as the business does not have to be located in Minnesota and the breach does not have to have occurred there. As long as a person or entity conducts business in Minnesota, retaining credit or debit card security data after authorization of the transaction will expose it to potential liability. Consequently, a person or entity selling to Minnesota customers is potentially liable under the Minnesota act.

The Minnesota act also holds businesses responsible for violations by their service providers. This highlights the importance of clearly addressing legal compliance issues in merchants’ agreements with their service providers and allocating


this risk appropriately. As the legal landscape becomes more complicated, legal compliance obligations will become a more significant issue in these agreements.

Is This Only the Beginning?

Legislation similar to the Minnesota law was also introduced in at least five other states: California, Connecticut, Illinois, Massachusetts and Texas. Interestingly, in California, Governor Schwarzenegger vetoed the legislation, expressing concern that it “creates the potential for California law to be in conflict with private sector data security standards” such as the PCI DSS and would “drive up the costs of compliance, particularly for small businesses.”

In Canada, the mandated five-year review of the Personal Information Protection and Electronic Documents Act has commenced. While introducing a data-breach-notification requirement is under consideration, specific data security retention prohibitions of the sort included in the Minnesota legislation seem unlikely. The strict liability provisions to which merchants are subject in Minnesota are even less likely to take root here.

Nevertheless, increased concern over data security issues in both Canada and the US, and the legislative trends south of the border, bear close scrutiny.

Contact: Wendy Gross in Toronto at [email protected]

US: Two Provisions of the USA Patriot Act Declared Unconstitutional

A judge of a US District Court ruled that two provisions of the USA Patriot Act are unconstitutional because they allow search warrants to be issued without probable cause. She found that the electronic surveillance and physical searches provisions under the Foreign Intelligence Surveillance Act (FISA), as amended by the Patriot Act, violated the Fourth Amendment’s guarantee against unreasonable search and seizure.

As a result of the Patriot Act amendments, FISA had permitted the Executive Branch to conduct searches and surveillance without first having to demonstrate to a court the existence of probable cause that the person had committed a crime. The Executive Branch simply needed to represent that the targeted individual may be an agent of a foreign power and certify that a significant purpose of the surveillance and searches is the gathering of foreign intelligence.


Several provisions of the Patriot Act (including the ones struck down in this decision) have been the source of intense controversy. Various commentators have



questioned their constitutionality and raised concerns over privacy implications.

In reaction to privacy concerns, the B.C. government amended the Freedom of Information and Protection of Privacy Act in 2004. The amendments significantly restrict the transfer outside of Canada of personal information held by public bodies in B.C.

The Québec government adopted Bill 86, which amended several private and public sector privacy laws in Québec, including the Act respecting the protection of personal information in the private sector. In particular, it amended Section 17 of the Act to stipulate that every person carrying on an enterprise in Québec who communicates personal information outside Québec or entrusts a person outside Québec with holding, using or communicating such information on his or her behalf, must first take all reasonable steps to ensure that the information will not be used for purposes not relevant to the object of the file or communicated to third persons without the consent of the persons concerned. (Certain specific exceptions are set forth in the Act.)

If the person carrying on an enterprise considers that the information communicated outside Québec will not receive the requisite protection, he or she must refuse to communicate the information or refuse to entrust a person or body outside Québec with holding, using

or communicating it on behalf of the person carrying on the enterprise.

Section 18(4) of the Act (which specifies certain situations under which consent is not required for the communication of personal information and which formerly indicated that consent is not required if the communication is required by law) has also been amended to specify that it applies only to the communication of information required by an Act applicable in Québec.

These changes appear to reflect a legislative trend in Canada directed at protecting Canadians’ personal information from mandatory disclosure under the Patriot Act.




Communications


Canada: Canada Announces Policy Framework for the Auction of Advanced Wireless Services (AWS) Radio Spectrum

On November 28, 2007, Industry Minister Jim Prentice announced the policy framework for the auction in May 2008 of the AWS spectrum in the 1.7/2.1 gigahertz (GHz) bands. A stated objective of the framework is to encourage new entry and foster more competition in the Canadian mobile wireless market.


The AWS auction design was hotly debated during much of 2007. On the one hand, potential new entrants sought spectrum set-asides and other measures to encourage new entry. On the other hand, the incumbent national mobile wireless operators and many other commentators argued that potential new entrants did not deserve any special treatment, and that all AWS spectrum should be auctioned to the highest bidder.

Minister Prentice has now settled that debate. Citing the goal of encouraging greater competition and further innovation, as well as lowering prices, improving service and providing more choices for consumers, the Minister has decided to set aside 40 megahertz (MHz) of bandwidth

for new entrants while leaving 65 MHz available for all contenders to bid for. His decision follows a public consultation on how best to conduct the auction process for the available spectrum.

Under the policy framework, 90 MHz of AWS spectrum will be auctioned in six paired frequency blocks (three of 20 MHz bandwidth; three of 10 MHz), mirroring the block assignments in the US. Three of the blocks will be reserved for new entrants (one of 20 MHz; two of 10 MHz), while the other three will be open to all bidders. Blocks will be auctioned by geographic service area. Depending on the frequency block, the country will be divided into either 14 or 59 service areas for bidding and licensing purposes. In addition to the AWS spectrum, the upcoming auction will encompass two other spectrum blocks: One, a 10 MHz paired block at 1.9 GHz, is a potentially valuable block located in the band occupied by Personal Communications Services (PCS) licensees. The other is an unpaired five MHz block at 1670 MHz.

The policy framework also calls for:

• Mandatory digital roaming service for cellular, PCS and AWS licensees outside of their licensed territory for at least 10 years. (Roaming is the ability of a customer of one service provider to access the wireless service of another service provider.)


• Mandatory roaming service for new entrants inside their licensed territory for five years, with a possible extension in limited circumstances.

• Mandatory sharing of antenna towers and sites (with exceptions based on technical limits or national security concerns), and the prohibition of most exclusive site arrangements. The new rules will apply to virtually all tower operators, including broadcasters.

• Roaming and tower/site sharing arrangements are intended to be commercially negotiated by the parties involved. Impasses will be settled by binding commercial arbitration.

The auction announcement does not propose any changes to the Canadian ownership and control rules applicable to mobile wireless service providers. Although the continued appropriateness of these rules is being considered by the Competition Policy Review Panel recently appointed by the federal government, the panel’s report will not be issued until after the auction is completed. Accordingly, auction participants intending to involve non-Canadians investors will need to take these complex rules into account as part of their auction preparation.

Applications from bidders will be due in March 2008. The auction will begin on May 27, 2008.

Contact: Lorne P. Salzman in Toronto at [email protected]

Canada: Canadian Cultural Product and the Long Tail: The New Economics of Production and Distribution in Canada — Part II

This article continues our four-part series exploring the effect of new technology on cultural products. This part examines the impact on production and distribution of feature films and specifically considers whether technological change may help or hinder local or independent Canadian titles.


As we all know, the state of independent filmmaking in Canada continues to be problematic in the face of domination by Hollywood blockbusters. Can new technology make a difference?

To understand this a bit better, you need to go back to the beginning. Films have been shown in cinemas for over 100 years, and many technological changes have occurred. Silent film gave way to sound in the 1920s. The coming of television in the 1950s drastically cut studios’ film output and accelerated the rise of independent talent and the agents that package them, but also provided a new outlet for films after their theatrical release. In the 1970s and 1980s, the business model shifted again



with the rise of the ‘wide release’ in newly multiplexed theatres and the advent of pay TV in cable homes. And in the 1990s, the perceived threat posed by the VCR faded as the studios discovered that the market for the sale or rental of videocassettes (and later, DVDs) dwarfed theatrical revenues.

To maximize return, Hollywood studios depend on a careful sequence of ‘windows’ for their product, with price discrimination on the basis of medium, time and territory. As the DVD window has increased in importance, studios have reduced the delay of that window from the theatrical release.

The theatrical window, once the only source of revenues for film, now accounts for only 20 per cent of the revenue of Hollywood films. Very few films recover their negative cost in theatres, even when foreign and domestic theatrical revenues are combined. The real return for the successful film comes in the subsequent DVD and television windows. However, the theatrical window is still an all-important venue for building promotion and awareness for those subsequent windows. In that sense, advertising spent on the theatrical window is seen as an investment intended to produce a much later return.

One relative constant has stuck through all these stages: the marketplace dominance of the Hollywood studios. Around the world, films distributed by the six Hollywood major studios garner over 70 per cent of the box office. And this is not a recent development. Hollywood

dominated world cinema back in the silent film era and has maintained its dominance through all these technological changes.

Why have Hollywood studios dominated for so long? After all, as noted, films are risky. Most Hollywood films do not recover their negative cost. And some independent films do very well, even when made much more cheaply — think of My Big Fat Greek Wedding. Moreover, the studios don’t have a monopoly on talent, and often despise and abuse it. There is a long list of books by successful Hollywood screenwriters that attack the studios’ creative judgment. As William Goldman famously said, “nobody knows anything.”

So how do the studios do it? It’s complicated, but it goes back to the “curious economics” of cultural products that were discussed in the first instalment. Most film revenue is garnered by relatively few titles. Yet it is very hard to predict which script will lead to a popular film, as opposed to a bomb.

The economics of cultural production, where almost all the cost is in the master copy and additional copies are relatively inexpensive, also comes into the equation. Given the high fixed costs of film, studios are always seeking the ‘blockbuster,’ which can not only recover its cost but also pay for a lot of failures. Realizing that occasionally an independently made film such as Little Miss Sunshine can become a hit, the studios have also dipped their toes into indie films through their ‘mini-major’ or specialty film divisions.


So how do the studios survive? The answer is size. If you can’t predict the winners, then you have to enter the race with a large number of likely candidates and the ad budget to promote them. Scale allows the majors to stay in the game until one of their films hits big. And when it does get a response, they seek to own or control the media in which the film will be exploited to maximize the downstream revenues. Some people say ‘content is king.’ But those in the industry might argue that distribution is king.

Studios also try to minimize risk by tending to focus on sequels and clones, and on ‘A-list’ talent that will appeal to a US audience. But in their constant efforts to drive ever-greater audiences to those hard-to-predict blockbusters, something is lost. The studios’ priorities have no reason to include the new, the experimental, the alternative, the exotic or the local film. As noted at the outset, we saw our theatre screens dominated by over a dozen Hollywood sequels last summer — Shrek the Third, Spider-Man 3, The Bourne Ultimatum, Pirates of the Caribbean: At World’s End, Harry Potter and the Order of the Phoenix, Ocean’s Thirteen, and on it goes. The reason is name recognition — and therefore, risk reduction.

This is a particular problem for national cinema in countries around the world. With the theatrical focus on Hollywood blockbusters, and an economic model based on massive advertising and a wide release, how can small local films find

an audience? Of course, with the help of private or government support, many local films may be made. But few may actually end up being distributed in theatres. In fact, almost 60 per cent of the films made in the UK in 2004 never got a theatrical release.

In 2006 in Canada, the overall theatrical box office was $831 million, about the same as for 2005.

And how did Canadian films do? Not very well. The situation fared best in terms of the French-language box office. In 2006, Canadian films got an impressive 17 per cent of the box office in French Canada, led by Bon Cop, Bad Cop, which got $9.7 million.

But the English-language box office continued to be disappointing: Canadian films got only about two per cent of the box office in English Canada.

On an overall basis, the government has hoped for a market share for Canadian films of at least five per cent. And in 2005, we actually exceeded that target, getting a 5.5 per cent share with the help of movies such as C.R.A.Z.Y. But in 2006, we were back down to 4.2 per cent.

The English language results in 2006 were led by Silent Hill, a video game adaptation, which took in $4.2 million, and Trailer Park Boys: The Movie, which garnered $3.7 million. Interestingly, those two Canadian films were both based on successes in other


media. Because they had name recognition, they got distribution in theatres.

But many Canadian films were never released in theatres. Those that did often opened on very few screens and had little advertising support. So it is no surprise that Hollywood films — which spend an average of $30 million each just on prints and advertising — accounted for the lion’s share of the revenue. As economic studies have shown, that will in turn drive the revenue for subsequent windows.

Can technology change this situation? Can the Canadian small film gain a better outcome?

Let’s start with the theatres. Some people thought the arrival of the multiplex in the 1980s would increase choice. More screens certainly provide opportunity to exhibit more different films. But it hasn’t always worked out that way. Often, a single blockbuster occupies two or three screens in a multiplex instead of one. And the films given exhibition slots are given much less time to prove themselves before they are discarded in favour of the next film prepared to mount a heavy ad campaign.

Theatres are now being pressed by film distributors to convert to digital projection. A key reason is to save money on the cost of 35 mm celluloid release prints. A film in wide release in North America may require 3,000 celluloid prints, each costing $2,000 or more. Using digital projection changes the economics. Once a digital file is

created of the film (storing about the same amount of information as 55 DVDs), additional copies can be made on a hard drive for less than $100. This can mean millions of dollars of savings to the distributor, who normally covers the cost of prints and advertising. This could be a real boon to the distributors of smaller independent films, who typically cannot afford the cost of a wide release using celluloid release prints.

However, it is the theatre that bears the cost of installing digital projection equipment — upwards of $100,000 per screen. So unless someone can come up with a way to cover that cost, theatres are reluctant to implement it.

One intriguing approach has been taken by the UK. In May 2005, the UK Film Council announced its Digital Screen Network. The Film Council used £11.7 million from its share of National Lottery funding to subsidize the installation of digital film projectors across the UK by the beginning of 2006. Through a bidding system, 209 cinemas were chosen across England, Scotland, Wales and Northern Ireland. They include 49 art house cinemas, 129 chain multiplexes and 31 mainstream independents.

Each cinema got a subsidy of £56,000 to install a digital projector. The subsidy covered more than half the cost. In return, each cinema had to commit to increase its screening time for ‘specialized’ films. What is a ‘specialized’ film? In essence,


the Council defined it as a non-mainstream film. This would include independent British films, subtitled foreign language films and even ‘intelligent’ Hollywood films released by mini-majors such as Sony Classics or Fox Searchlight.

The Film Council strategy was clearly intended to broaden the range of films available to audiences across the UK and in particular, to allow distributors to grow the audiences for non-mainstream films.

Will it work? Recall that the UK has about the same population as California. Typically in Britain, Hollywood films get over 70 per cent of the box office. The average mainstream film is released on 300 screens in the UK. Until the Digital Screen Network was introduced, the average specialty film was released on only 17 screens. And while about half the UK releases are specialty films, they achieve only five per cent of the box office.

Based on the commitments from the cinemas, the Council estimates that the screening of independent films should increase from 75,000 in 2006 to 165,000 by 2009. It also estimates that the number of tickets sold could increase by $4 million.

This is an exciting experiment that may help the smaller film. But there is one obvious fly in the ointment. While the cost of prints will go down so the distributor may be able to access more theatres, the need to advertise still remains. And if you cannot afford the intensive TV ad campaign

that goes with every Hollywood film, how do you get bums in seats? That is the conundrum faced by every small film.

The Film Council has tried to partly address this by fully financing a new website called Myfilms, where moviegoers can recommend films to each other. The Council hopes that in this way the movie business “will start to follow trends in music, with online communities championing a more diverse range of talent.” It remains to be seen whether this will work.

In Canada, we have a very similar situation in that smaller film distributors also cannot afford the costs of prints and ads to support a wide release in theatres. All too often, they roll out in only one or two cities. Canada’s largest theatre chain, Cineplex Entertainment, has been negotiating with a group of US exhibitors to introduce digital projection on a basis where the costs can be passed back to the film distributors through an access charge. That will still make economic sense to the distributors given the cost of release prints, so eventually we will have the benefits of digital platforms in theatres. But unlike the UK, the theatres will have no obligation to provide more screenings for smaller films. If they do so, it will be because those films are able to attract attention from niche audiences that make a screening worthwhile.

The video store market is also a problematic model for the distribution of local films. Wal-Mart and Costco sell DVDs at discount but carry only a limited


selection of bestsellers. And as for video stores, it is very hard for small films to get access to their limited shelf space, given the glut of films being offered to them.

So that takes us to the Internet. And with the Internet comes the ‘long-tail effect.’

The term ‘long tail’ was coined in 2004 by Chris Anderson, the editor of Wired magazine. His book, The Long Tail, was published in July 2006 and immediately became a bestseller.

As mentioned, 20 per cent of the titles account for 80 percent of the sales. (In fact, in North American theatres, only five per cent of the titles given screen time typically get 80 per cent of the revenue).

When titles are graphed against popularity in terms of sales or eyeballs or tickets, a long tail extends far to the right, consisting of the titles that get relatively few sales.

Chris Anderson’s new insight was that with the rise of the Internet and companies such as Amazon (for books), Rhapsody (for music) and Netflix (for DVDs), new ways to market, promote and distribute these lesser-known titles are available. The Internet gives unlimited shelf space to new or old titles, and search engines make finding these titles much easier. If storage and distribution costs can be minimized, thriving business could satisfy demand for titles that would never be stocked by bricks-and-mortar stores with their limited shelf space.

The Netflix numbers illustrate the long-tail phenomenon. Netflix started up an online DVD rental service in 1998, and has grown to over 6.3 million subscribers in the US. (It does not operate in Canada.) A normal Blockbuster or Rogers DVD rental store stocks about 3,000 titles. But Netflix has 75,000 titles on offer. And according to Anderson, 21 per cent of its rentals involve film titles outside the top 3,000.

In Canada, an equivalent DVD rental service is provided by Zip.ca, though its number of subscribers is still very small — only about 37,000 at last count. But Zip.ca shows the same support for the long tail. Zip.ca has made two charts available. The first shows that 25 per cent of its rental requests are for about 40,000 titles that are not frequently requested. The second chart shows the percentage of rentals of titles from the 1980s and 1970s compared with the 1990s. And you’ll see the long-tail effect is alive and well.

So that is good news. Even if you can’t find a small film in a theatre or in a video store, you can certainly find it on the Internet. But for smaller films to benefit, they need to generate interest through e-mail lists, cinema clubs, blogs, community websites, MySpace and the like. The UK experiment with Myfilms provides a useful example.

The bad news is that the Internet has not emerged as a vehicle for financing high-cost audiovisual content, such as feature films or TV shows. The Internet is a superb aggregator and sales venue for cultural


product already financed and created. It may increase the downstream revenue for smaller titles. But though it has plenty of inexpensive user-generated content, it has not yet emerged as a means to finance a film costing $3 million or more.

As for the prospect of downloading films on the Internet, this is beginning to happen on a legal basis. However, the studios carefully limit such downloads in terms of time and geography to preserve the viability of the theatrical and DVD markets. Given the understandable studio concerns over piracy, this is not a market that is likely to displace existing venues.

So in the end, the long tail will not eliminate the economic problems faced by the independent film. Government support will continue to be needed if we want a flourishing Canadian film sector. The nature of that support deserves an analysis of its own. As mentioned, the key elements will include the use of subsidies and tax credits, and the imposition of licence conditions on TV broadcasters, particularly pay TV services, to provide financing, promotion and a reliable window for Canadian films. We may also want to take a leaf from the UK experience and provide specific support for websites that can generate a critical mass of interested filmgoers.

In the next issue of the TLQ, we will look at the future of the television sector in Canada in the face of technological change.

Contact: Peter S. Grant in Toronto at [email protected]

International: Voice over IP Services — Regulatory Perspectives from the Developed and Developing Worlds — Part IV

This article completes our four-part series on the regulatory issues surrounding voice over Internet protocol (VoIP) services. It examines the challenges faced by telecommunications regulators in developing countries in adopting a more permissive approach to VoIP and other service competition. It also provides examples of two countries that have made the transition.


Where country regulators and telecommunication policy makers permit a greater degree of VoIP service competition, they tend to encounter some recurring regulatory challenges. Some of these are the same as the developed countries’ challenges discussed in this series’ first instalment. These include re-examining tariff and other economic regulation, fair disclosure of service capabilities and limitations, and public interest concerns such as the proper operation of emergency services in VoIP service environments.

Other concerns include anticipating and resolving licensing anomalies. It is



important that previously licensed service providers not be subject to licence obligations or other terms and conditions that are more onerous than, or otherwise not comparable to, the terms that apply to new entrants.

A similar concern may arise in connection with universal service policies and funding programs. It will be essential that all licensees fairly contribute to any universal service funding schemes. It will also be essential that all competing service providers have non-discriminatory access to universal service funding, and can otherwise fairly participate in universal service programs including competitive bidding for new service development projects.

A recent International Telecommunications Union (ITU) publication summarizes the tension between the challenges and opportunities of effective VoIP regulation in the following terms:

Regulators recognize that although VoIP poses increasing challenges to legacy operators, it also brings new opportunities to end-users for more affordable services. In many ways, the rise of VoIP has crystallized the delicate balancing act that many regulators have been performing as regulatory reform has been implemented ever more widely. Weighing in on one side of the scale are the commitments of the World Summit on the Information Society (WSIS) to encourage low-cost access to

ICT services, while the other end of the scale balances the desire to protect incumbent operators — especially when incumbents remain at least partially government-owned…

The rise of VoIP is emblematic of the crossroads at which the ICT sector now finds itself. Regulatory practices and wisdom built upon the experiences of the heavily regulated PSTN era are now meeting head on the largely unregulated Internet world. Which model will apply as these two worlds converge? Or will hybrid or entirely new regulatory models be developed?

Countries wishing to adopt a more permissive approach to VoIP and other service competition can look to a number of sources for guidance on regulatory policies. Regulatory studies commissioned by such institutions as the World Bank and the ITU offer a broad range of detailed guidance. Among the specific ITU initiatives has been the definition and adoption of regulatory guidelines to facilitate a harmonised ICT market in West African states — a project also supported by the Economic Community of West African States (ECOWAS) and the European Union. Among the agreed-upon guidelines are a model ICT policy and law, and specific best-practice guidelines on licensing and interconnection.

The transition from restrictive to more permissive regulation is best illustrated by specific examples. Both Nigeria and Kenya


previously prohibited or substantially restricted the provision of VoIP services. Both countries have since introduced significant changes in their regulatory practices that encourage VoIP service development and competition.

In February 2005, the Nigerian Communications Commission (NCC) published a notice of intention to issue guidelines on VoIP and related international access/gateway issues. The NCC has since issued the corresponding guidelines, which create two categories of international gateway licence and clarify related rights and obligations.

As a result, international VoIP service markets have been fully liberalized. Any potential service provider may apply for one of the two categories of international gateway licence. The new guidelines clarify that existing digital mobile licensees may carry third-party traffic and deliver it to international destinations, subject to obtaining an international gateway licence.

The guidelines also clarify that the NCC will not issue VSAT licences in connection with the delivery of international traffic, but will rely on international gateway licensing instead. Finally, the guidelines confirm that enterprises operating private domestic networks may implement VoIP over those networks.

It is also interesting to note that the executive vice chairman of the NCC has specifically emphasized the advantages of

VoIP network technologies and services for promoting universal access to telecommunications services, stating, “Nigeria welcomes the use of VoIP, and encourages telecommunications operators to deploy it where applicable.”

Similarly, the Communications Commission of Kenya (CCK) has published guidelines “On the Provision of Voice over Internet Protocol (VoIP) Services in Kenya.” The CCK notice that launched a public consultation on the proposed guidelines includes the following statements:

There can be no question that VoIP represents an innovative technological advancement, which confers economic advantage to users. There can equally be no doubt that VoIP allows for choice and affordability and promotes competition.

In a bid to confer the advantages that this technology presents to end-users, the Commission has, through the post exclusivity regulatory strategy, adopted a technology neutral regulatory framework that will facilitate the use of IP based technologies including VoIP. The implementation of the framework will allow licensed infrastructure providers such as Internet Backbone and Gateway Operators (IBGOs), Broadcast Signal Distributors (BSDs), Commercial VSAT Operators (CVOs) and Public Data Network Operators (PDNOs), to carry any form of multimedia traffic including IP traffic


(e.g., VoIP). Licensed application providers and in particular Internet Service Providers have been allowed to offer end-users VoIP services.

The final guidelines include a review and commentary on different configurations of VoIP services, but conclude with a discussion of the regulatory obligations that VoIP service providers will be required to meet. The CCK emphasizes the following regulatory requirements:

• Emergency Services: Service providers shall be required to provide emergency services within their networks.

• Interconnection: Service providers shall be required to enter interconnection and/or termination agreements with licensed network operators.

• Universal Service: Service providers shall participate in the provision of universal services as may be directed by the Commission from time to time.

• Quality of Service Levels: Service providers shall meet the quality of service requirements set by the Commission.

• Billing Accuracy: Service providers shall establish a procedure to ensure the accuracy of their billing systems.

• Numbering Plan: Service providers shall comply with the numbering plan prescribed by the Commission.

• Vertical Integration: In order to ensure a level playing field and sustainable market segmentation in the introduction of VoIP services, the Commission shall prohibit vertical integration between infrastructure and service licensees.

Concluding Comments

In this series, we have examined and identified shortcomings in arguments supporting more restrictive responses to VoIP service offerings. Given the tremendous efficiencies of IP networks, their cost advantages and their potential to deliver the broadest possible range of telecommunications services, the deployment of IP networks and competitive delivery of VoIP services should be actively encouraged by telecommunications regulators and policymakers in both the developed and developing worlds.

Though sometimes seen as a limitation, the fact that the most effective VoIP services require broadband Internet access can also be seen as a regulatory opportunity. By adopting regulatory practices and policies that encourage delivery of VoIP services, regulators and policymakers will encourage the deployment of broadband access networks. Creating an environment of service revenue and profit incentives


may provide the most effective possible stimulation of broadband deployment and help close the ‘digital divide.’

Creating a regulatory environment conducive to VoIP service delivery can therefore be seen as much more than a timely and narrow regulatory challenge. A regulatory framework that permits and encourages VoIP service delivery will be a regulatory environment with much broader positive effects. This includes strong incentives to deploy next-generation broadband networks, which can in turn deliver the broadest possible array of consumer services at the lowest possible prices.

Contact: Stephen Rawson in Toronto at [email protected]



Clean Technology


Canada: Climate Change, Clean Tech and Innovation — Leading by Example

The Province of B.C. takes its economic development and environmental stewardship seriously and leads by example to address climate change, as well as provide opportunities for clean technology companies. It recently became the first province in Canada to legislate broad-based greenhouse gas reduction targets, with the Greenhouse Gas Reduction Targets Act. Although many celebrities and politicians appear to be jumping on the global-warming bandwagon, B.C. has taken the first steps necessary to provide certainty around the timing of greenhouse gas emission (GHG) reductions.


While the consensus has been that GHG reductions would come, the big question was “When?” This uncertainty around timing makes it harder for capital markets to invest and businesses to plan production schedules. These difficulties limit the level of innovation and growth of new clean technology companies. Being too early to market with an electric car has proven to be as costly as being too late into the hybrid auto market.

In addition to providing certainty for businesses and investors, the B.C. government is committed under the Act to being carbon neutral for the 2010 calendar year. Also, the Act requires work-related travel by public officials to be carbon neutral for the 2008 and 2009 calendar years. This approach of ‘leading by example’ creates opportunities for businesses and clean technology companies to assist the B.C. government with reducing its GHG emissions.

The Act adopts a phased-in approach up to 2020 for the level of GHG reduction. This will allow investment and businesses time to align business models and production schedules. The Act sets two province-wide targets for greenhouse gas reductions:

• by 2020 and for each subsequent calendar year, B.C. greenhouse gas emissions will be at least 33 per cent less than the level of those emissions in 2007; and

• by 2050 and for each subsequent calendar year, B.C. greenhouse gas emissions will be at least 80 per cent less than the level of those emissions in 2007.

Interim targets will be set for 2012 and 2016, which will be determined before the end of 2008. The Premier of B.C. has appointed a Climate Action Team, which


includes several Nobel Peace Prizes winners and senior executive from business, to advise and report on the interim targets by July 2008. After the team delivers its report, a process for public comment and input will begin.

Cheryl Slusarchuk is the Chair of the B.C. Climate Action Team.

Contact: Cheryl L. Slusarchuk in Vancouver at [email protected]



Biotechnology/ Life Sciences


Canada: Biotech Licences — Sublicensing Revenue Considerations

Biotech licences are very often lengthy contracts running to 30, 50, 70 or more pages. This reflects the fact that the licences are usually long-term, worldwide and exclusive arrangements involving products of strategic importance to at least one of the parties.

Many topics must be covered in the contract for it to effectively form the basis of the parties’ relationship. Two of the most important topics are the licence grant and the royalties. The parties are well-served to devote their maximum attention and thought to these clauses, since they will in large measure decide whether the parties receive the benefits they expect from the relationship.

This article considers some issues for licensors and licensees when structuring royalties on sublicensing revenue to licensees from the licensed technology.

Biotech licences very often charge royalties on ‘net sales’ by the licensee and its sublicensees. Net sales are typically defined as the gross invoice price of the products less any deductions that effectively reduce the selling price (e.g., discounts or returns) and any

extraneous charges (e.g., insurance, duties or shipping). This royalty structure effectively creates a carrying charge on the products that must be collected on sales by both the licensee and its sublicensees. So long as the net sales royalties constitute a satisfactory return to the licensor, any other financial arrangements the licensee may make with its sublicensees are of no importance to the licensor.

The royalty situation becomes more complicated when the licensor also wants to share in the total revenues (from all sources) its licensees may make from the licensed technology. This is the case with profit-sharing arrangements, which have become more common in the biotech industry.

In these broader revenue-sharing arrangements, licensors are concerned that their licensees will make earnings from the licensed technology that fall outside what is royalty-bearing under the licence. Indeed, their licensees may actively devise ways to find such non-royalty-bearing revenues.

In addition to licence fees, milestone payments and royalties received by licensees, licensors will want the royalty provisions to cover ‘all other consideration’ received in connection with the ‘licence, sublicense, assignment or transfer of rights’ with respect to the licensed technology, as well as all ‘other operating income’ received with respect to the development and commercialization of the


licensed technology. To guard against licensees avoiding royalties by taking non-monetary consideration, licensors will want the royalties to also capture the fair market value of any non-monetary consideration received.

Though these types of clauses protect the licensor, they may be problematic to licensees who do not want to pay royalties on certain technology development or commercialization arrangements with their partners.

One such arrangement is where the licensee sublicenses the technology to another biotech or pharmaceutical company, and receives back a research and development contract. Licensors will want to capture the research and development revenues to the licensee as monies earned from the licensed technology. However, with research and development activities come expenses, so licensees must be careful to ensure the royalty-bearing revenues are their research and development profits, and not their gross income from the research and development contract.

Another arrangement that licensees may use with sublicensees are equity investments in the licensee by the sublicensees. Licensees will typically want to ensure these equity investments are not captured by the royalty provisions of the licence. Licensors may resist this exclusion, however, since these investments may be done based on valuations that are very favourable to the licensee. The investments are really just a mechanism to either fund research in the licensee or to pay for the technology sublicensees.


These examples illustrate the level of detail that needs to be considered in structuring royalty arrangements in biotech licences to ensure a fair bargain that protects both parties’ interests. Lack of attention to royalty terms when negotiating biotech licences is a recipe for future disputes, due to the many ways — both closely related and not-so-closely related to the licensed technology — that licensees can make returns from licensed biotechnology.

Contact: Paul Armitage in Vancouver at [email protected]

International: Canada Is First to Grant WTO Compulsory Licence for Export of Generic Drug

In October, Canada became the first country to issue a compulsory licence to the generic drug manufacturer Apotex to produce and export a patented medicine for the AIDS antiviral drug TriAvir to a developing country pursuant to a plan negotiated under the auspices of the World Trade Organization (WTO).

WTO Doha Declaration and Subsequent Negotiations

On November 14, 2001, at the conclusion of the WTO’s Ministerial Conference at Doha, the



Declaration on the TRIPS Agreement and Public Health (Doha Declaration) was issued in an effort to address the difficulties faced by developing and least-developed countries in accessing patented medicines for public health problems through WTO member compulsory licensing.

One of those obstacles was the compulsory licence provision in the WTO Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS), which requires that such licences be issued predominantly for the supply of the domestic market in the licence-granting country. Accordingly, WTO member countries with manufacturing capabilities were not permitted to issue a licence for the export of patented pharmaceuticals to developing and least-developed countries without such capabilities. The Doha Declaration recognized this and proposed further negotiations to develop a solution.

On August 30, 2003, the WTO’s General Council issued a decision waiving the requirements of TRIPS that (i) compulsory licences be issued predominantly for the domestic market, and (ii) “adequate remuneration” be paid to the right-holder in the importing country, thus facilitating the use of compulsory licensing as a means of delivering patented medicines to developing and least-developed countries facing public health problems.

Implementation in Canada

In 2004, Canada became the first country to implement the August 2003 General Council decision. Bill C-9, An Act to amend the Patent

Act and Food and Drug Act (The Jean Chrétien Pledge to Africa), provides for compulsory licences for the export of generic versions of patented medicines to countries with dire pubic health problems.

Included within the Canadian legislation are provisions intended to protect the rights of the patent-holder vis-à-vis the medications themselves and their commercial value. Before being issued a compulsory licence, a generic manufacturer must certify its attempt to procure a voluntary licence from the patent-holder on reasonable terms and conditions. The compulsory-licence-holder is obliged to pay royalties to the patent-holder, the sum of which is contingent on the total value of the medication being exported under the licence and on the country to which it is being exported. Higher royalties will apply in the case of exports to countries with relatively high rankings on the United Nations Human Development Index (UNHDI), while lower royalties will apply for shipments to countries with low UNHDI rankings.

The patent-holder may apply to the Federal Court to terminate the compulsory licence if it can demonstrate that the relevant medication has been re-exported in violation of the 2003 WTO decision or that it had been exported to a country other than the one specified in the licence. In addition, if the price of the generic medication is 25 per cent or greater than the cost of its patented equivalent in Canada, the patent-holder may apply to the Federal Court to have the compulsory licence terminated or to secure a higher royalty rate, on the grounds


that the generic manufacturer’s export activities are commercial in nature. To facilitate the patent-holder’s ability to enforce these rights, the compulsory-licence-holder is under an obligation to notify the patentee of the quantity of medication in each export shipment and of the name of each party that will be handling the product in transit from Canada to the destination country.

Compulsory Licence for TriAvir

On October 4th, 2007, Canada notified the WTO that it had authorized Canadian generic producer Apotex to manufacture and export a generic version of TriAvir, a patented AIDS medicine. This generic version will be called Apo-triAvir. Canada’s notification completes the second step of the initiative commenced by Rwanda on July 17th, 2007, when it notified the WTO of its intention to import 260,000 packs of TriAvir.

TriAvir is a fixed-dose combination product of zidovudine, lamivudine and nevirapine. The patent for the first two of the antiretrovirals (ARV), zidovudine and lamivuine, is held by GlaxoSmithKline (GSK) while Boehringer Ingelheim owns the patent on the third ARV, nevirapine. Though both GSK and Boerhringer could have requested and received royalties from Apotex under Canadian legislation, GSK agreed to waive any royalties on the basis that ARV will be provided on a non-profit basis for humanitarian purposes. Likewise, Boehringer Ingelheim offered Apotex a royalty-free, voluntary licence to manufacture and export products containing nevirapine to Rwanda.

Approval of the Apotex generic is the first time a country has agreed to allow export of a generic version of a patented medicine to a developing country.

Contact: Anita Nador in Toronto at [email protected] or John W. Boscariol in Toronto at [email protected] or Simon V. Potter in Montréal at [email protected] or Orlando E. Silva in Toronto at [email protected] or Brenda C. Swick in Ottawa at [email protected]






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TLQ Vol3 Issue4 E

Documents

Transcript of TLQ Vol3 Issue4 E