Industry Committee on Oct. 18th, 2012

[The Chair, Conservative, David Sweet]

Ladies and gentlemen, bonjour à tous. Welcome to the 42nd meeting of the Standing Committee on Industry, Science and Technology.

We have two witnesses before us right now. One is Diane Lank, who is from Desire2Learn Incorporated. From the Entertainment Software Association of Canada, we have Jason Kee, who is a director.

Madame LeBlanc, you had something to say before the witnesses start.

[Hélène LeBlanc, NDP, LaSalle—Émard, QC]

Good morning, Mr. Chair.

I wanted to point out that representatives of the manufacturing sector are here on Parliament Hill. I had the pleasure of meeting them. Since we were talking about future committee business, I would like to remind committee members that we passed a motion to study various sectors, including the manufacturing sector, in the context of innovation. We could consider that motion for further study.

Thank you very much, Mr. Chair.

[The Chair, Conservative, David Sweet]

I'm sorry, I missed the first portion. Which motion are you talking about, Madame LeBlanc?

[Hélène LeBlanc, NDP, LaSalle—Émard, QC]

It was a motion that we passed and that is already on our to-do list. It was about taking a look at industry in Canada, of which the manufacturing sector is part, in the context of job creation and innovation. With manufacturing sector representatives present, I wanted to take the opportunity to remind my distinguished colleagues that we have passed the motion and that we could study it in the near future.

It is just a reminder.

[The Chair, Conservative, David Sweet]

Okay, we'll discuss it at the next business meeting.

[Hélène LeBlanc, NDP, LaSalle—Émard, QC]

Of course. I just wanted to point that out, given that the representatives are here.

[The Chair, Conservative, David Sweet]

Fine.

[Hélène LeBlanc, NDP, LaSalle—Émard, QC]

Thank you.

[The Chair, Conservative, David Sweet]

I have introduced our two witnesses, and we'll begin. We'll use the order that is on our agenda, beginning with Diane Lank.

I believe the clerk mentioned to you that you would have six to seven minutes, but we only have two witnesses today, so I will give you some latitude if you go over a bit. I think all the members will be fine with that.

Please go ahead with your opening remarks, Madam Lank.

[Diane Lank, General Counsel, Desire2Learn Incorporated]

I appreciate that. I won`t have to speed read.

Good morning, Mr. Chair, and esteemed members of this important committee.

My company is honoured that its views are being solicited on this important topic of IP in Canada. I am personally honoured to be appearing before you. Thank you for the opportunity.

My name is Diane Lank and I serve as general counsel for Desire2Learn Incorporated, based in Kitchener-Waterloo.

Our company is a remarkable success story, not only by Kitchener-Waterloo standards but by any measurable standard. Our success, however, has not been without its bumps. We were founded by John Baker in 1999, when he was a student in systems design engineering at the University of Waterloo. He incorporated the fledgling company a year later and John continues to serve as our president and CEO.

Our company provides e-learning. Today we help over eight million people in their learning endeavours. It is our goal to break down barriers and to engage, inspire, and enable people worldwide to achieve their potential.

We count among our first clients the University of Guelph, and the University of Wisconsin, both of which remain clients to this day. Now, however, we touch more than higher education. Our clients include various K-12 districts, corporations, and associations. We're still based in Kitchener-Waterloo—in fact, across the street from our original office--but we now have subsidiaries in the United States, the United Kingdom, Australia, Singapore, and the newest member of our Desire2Learn family, D2L Brazil.

I joined the company in 2005, when we had about 50 employees. At that point, John and I agreed that I'd start part-time to see how it would go. Within a month I was more than full-time. Then the fun began.

A few months after I started, we got news that our major and much larger competitor, Washington, D.C. based Blackboard Inc., had sued us for patent infringement in the U.S. District Court for the Eastern District of Texas. The news arrived on a Wednesday afternoon before our users' conference, slated to begin the following weekend in Guelph. Because our clients were largely academic institutions that valued transparency, we immediately decided to be as transparent as possible. We advised our staff on Friday and announced to our users at the beginning of the conference on Sunday that we had been sued.

Initial estimates, which later proved to be significantly underestimated, suggested that during the next two years we would be incurring legal fees of about $2 million in U.S. funds—and that was well before parity—to fight the suit. The underestimate did not include the significant non-legal costs associated with U.S. litigation: costs of video recording and transcribing dozens of depositions, oral examinations, in Canadian parlance, producing literally millions of pages of documents, having those documents reviewed so that we knew what we were providing to our main competitor.

Then there's the review of the millions of pages that Blackboard produced: motions, experts on damages and technology; travel to hearings, depositions, and meetings; legal fees and costs associated with the re-examination that we filed with the United States Patent and Trademark Office. The list goes on and on. The out-of-pocket and legal fees and related expenses don't begin to address the distraction of litigation within the company, or the dampening effect on our sales.

In February 2008, after millions of dollars had been spent, and a two-week trial in lovely Lufkin, Texas, we lost. The Lufkin jury determined that the Blackboard patents were valid and that we had infringed them. We were subject nearly immediately to an injunction preventing us from selling the version our software had been found to have been infringing.

I'll never forget the trip back from Texas after the loss. Desire2Learn's major brains trust was on the plane. As soon as the seat belt sign was turned off, John and the other leadership of the company began aisle discussions on workarounds to make sure we could quickly release a product that we believed would not infringe. By the time we landed, they had a plan. Within 30 days we had a new product that we believed avoided the patent. Remarkably, all of our U.S. clients agreed to be upgraded in the short three-month timeframe the court permitted. And, throughout the litigation, we lost not a single client.

In July 2009, nearly three years to the day after the litigation began, the court adopted our view at the U.S. Federal Court. It was a complete victory.

In the meantime, our competitor had filed additional actions against us: one in Texas, over a new patent that was issued; one in the United States International Trade Commission—which is a very interesting topic for another day—a quasi-judicial body in the U.S.; and one in the Canadian Federal Court, over a patent that the Canadian Intellectual Property Office had granted. As a result of the new suits, the overwhelming U.S. appellate win, and the undeniably smeared reputation that Blackboard had received in the marketplace, all of the litigation was favourably settled in December 2009.

Since that time, Desire2Learn has grown exponentially. Today we boast nearly 600 employees worldwide, with approximately 90% of our staff located here in Canada.

What could Canada have done to help us avoid the issues? As a practical matter, probably very little. If a competitor wants you out of business, suing you, especially in a U.S. court, is a pretty good bet.

Addressing the Canadian IP regime in a vacuum serves no useful purpose. We must accept the realities and be prepared to play under the U.S. rules. Few Canadian companies have the luxury of being exclusively Canadian. Upwards of 70% to 80% of our business is U.S.-based; even though we're expanding globally, the U.S. is still our largest market.

We've now adopted the if-you-can't-beat-them-join-them mentality; we're filing for patents. Although we use Canadian patent counsel, all of our applications are initially filed in the U.S. While we do seek Canadian protection for both trademarks and patents, protection solely in Canada would not be helpful, either offensively or defensively.

As a government initiative, it might be worthwhile to invest in educating start-ups about the importance of protecting their IP and providing some guidance about how to prepare to defend themselves if challenged. These educational initiatives may take the form of classes about IP in engineering or through organizations such as our local Communitech or, perhaps, even through a really good e-learning company I know about.

You may also wish to look at Canadian patent fees. In some areas they're quite costly. For example, Canadian patent fee maintenance may be prohibitive to new companies. The maintenance fee regime differs from the U.S, where maintenance fees do not begin until a patent is issued. Assistance in funding patent applications may also be useful. In our experience, it costs between $8,000 and $12,000, excluding filing fees and significant internal costs, to file a utility patent on either side of the border.

Educational institutions can also be of some help. Institutions of higher learning can and should, under appropriate NDAs, reach out to companies where they believe the educationally created technology might come into the best use. We're going through that right now with a U.S.-based client who sought us out.

I know this is a heady challenge, but we encourage Canada to seek more cross-border cooperation with the U.S. patent system, both the U.S. Patent and Trademark Office and the judicial system. Less than one month after we lost our jury trial in Texas, the patent office in the United States found the patent at issue to be invalid as a result of the re-examination we had requested more than two years earlier. The court refused to suspend the litigation while the PTO was engaging in its re-exam, but had the litigation been suspended during the re-exam, we would have saved millions of dollars in fees and costs. If somehow the U.S. judicial system were encouraged to work with the Patent and Trademark Office, rather than at odds with it, it would make for a more efficient system.

We'd also like the U.S. system to be more cognizant of damages that should be actually awarded in patent cases. Although the patent over which we were sued had very little relation to our overall product, the initial request by Blackboard was for a licensing fee of 45% of all of our revenue.

There must be some relationship between the value of the patented technology and the product as a whole. At some point, it would perhaps be very useful to have a discussion, especially with the United States, about the wisdom of offering patent protection for software. We believe it would be a sounder approach with copyright, like a book. Why should software or business methods be patentable? In some jurisdictions, particularly the European Union, they are not. In reality, the patent regime, at least in the U.S.A., is more related to business wars than to IP protection. In our case, our competitor simply wanted to buy us. They had tried numerous times before. We refused, and they sued.

Finally, all but the largest players are naive and ignorant about lawsuits, unless, like us, the company has had the misfortune of experiencing one. At the end of the day, Canada can't really influence litigation trends, good or bad. Education can help, but just to be aware of the risks. Canada can arm our businesses to be aware of the situation and try to mitigate risks where possible and feasible. In a perfect world, the U.S.A. would understand that qualified judges would be better prepared to hear patent cases, as is the procedure in Canada, but Canada is not going to disturb the U.S. jury system. Maybe Canada could play a role it has so successfully played in other areas: the lead in bringing various parties to the table to consider seriously the issues of intellectual property, what should be entitled to protection, and how.

I come with more questions than answers, and perhaps a good story, but more challenges than solutions, and few firm recommendations. The IP regime in Canada, if properly approached, may help others avoid our situation. Given our history, one is left to wonder what would have happened to our company had it not faced three and a half years of brutal, exceedingly costly, and time-draining litigation.

Thank you for your attention.

[The Chair, Conservative, David Sweet]

Thank you, Madam Lank.

Now on to Mr. Kee.

[Jason Kee, Director, Policy and Legal Affairs, Entertainment Software Association of Canada]

Thank you, Mr. Chair.

My name is Jason Kee. I am the director of policy and legal affairs with the Entertainment Software Association of Canada. ESAC is the industry association representing companies in Canada that make, market, and distribute games for video game consoles, hand-held and mobile devices, personal computers, and the Internet.

Video games are the fastest growing entertainment medium in the world, with some blockbuster titles rivalling Hollywood movies in terms of sales and excitement. In 2011, Canadian retail sales of entertainment software and hardware grew by 3% to reach $2.5 billion. Sales are currently projected to continue growing and obtain revenues of $3 billion by 2016.

Canada has established itself as a world leader in the development of video games. Canadian game publishers and developers create some of the most successful titles. Canada is now the third most successful producer of video games in the world, second only to the United States and Japan. We are first on a per capita basis. The Canadian entertainment software industry has expanded at a phenomenal rate, and is projected to grow at 17% over the next two years despite a challenging economic climate.

[The Chair, Conservative, David Sweet]

Just a moment, Mr. Kee.

Mr. Lake.

[Mike Lake, Conservative, Edmonton—Mill Woods—Beaumont, AB]

If you wouldn't mind slowing down just a touch, that would be great. We only have two witnesses today. It seems that you are talking pretty quickly. I am trying to jot down some notes. We're willing to give you a little extra time in terms of the opening statement as the Chair had mentioned.

[Dan Harris, NDP, Scarborough Southwest, ON]

It's easier for the translators.

[Jason Kee]

Thanks. The industry employs almost 16,000 people in a variety of highly skilled and high-paying jobs at nearly 350 companies across the country. Entry-level workers in the industry earn almost twice as much as the average recent college graduate. The average salary across all Canadian provinces is just under $75,000 per year, which is twice the Canadian median. The industry directly contributes $1.7 billion to the Canadian economy and billions more indirectly. Furthermore, game companies drive research and innovation, with 55% of all game companies developing proprietary technology and devoting 25% or more of their overall production budgets to research and development.

Canadian game developers and publishers are clearly world leaders in innovation and creativity, and they contribute significantly to the Canadian knowledge economy. These companies are in the business of creating, financing, and commercializing IP and of developing, marketing, and selling an array of entertainment software products and services to a wide range of customers. Consequently, intellectual property is the cornerstone of our industry, and strong protection and enforcement of IP rights are crucial to the continued growth and success of our sector.

In today's market, developing and publishing a best-selling video game title is a high-risk endeavour often requiring massive investment. A high-end title will typically cost $15 million to $40 million to make, with teams of 100 to 200 people working together for at least two to three years to complete it. It is expected that these development costs will simply continue as we introduce new gaming devices.

The vast majority of revenue in the games industry is earned from upfront sales earned immediately after a game is released in the market but, due to the highly competitive nature of our marketplace, there is a considerable risk that a game will not be able to sell enough units to recoup these million dollar investments. Consequently, game companies must use the revenues from successful titles to offset development costs for the less successful games. In this type of market, piracy of video game software is devastating because it siphons the revenue required to recover the enormous investments necessary to develop successful game products and, left unchecked, leads to studio closures and lost jobs.

By providing rights holders with the tools they need to protect their rights and pursue those who facilitate piracy, a robust IP regime enables creators and companies to choose for themselves the best way to make their products available to the marketplace. This encourages investment in the development of new products, services, and distribution methods, and supports a diverse range of new and innovative business models, which in turn fosters legitimate competition, more consumer choice, and ultimately, lower prices for consumers.

One example of this in the recently passed Bill C-11, the Copyright Modernization Act, are the new provisions aimed at preventing circumvention of technological protection measures, or TPMs, that are used to protect copyrighted works. These are critical to the video game industry because our industry makes extensive use of sophisticated TPMs to protect our products, but in the absence of a legal prohibition circumventing this form of copy protection, a robust and lucrative but illegitimate market for devices and services specifically designed to break our copy protection and facilitate widespread piracy has developed. Indeed, in Canada, commercial operations selling these devices and services that enable piracy of our games operate openly and, consequently, Canada has had the unfortunate reputation of becoming a major transshipment hub for these devices.

Moreover, we are in the midst of a fundamental change in the way we consume our content. Creators increasingly use online platforms and other new and innovative distribution methods to obtain their content. Strong anti-circumvention measures such as those contained in the bill are essential, not only to prevent piracy and allow creators to determine how their works will be used, but also to ensure that the new platforms are secure and maintain the integrity of the nascent and developing digital marketplace. The bill provides urgently needed measures to pursue those who facilitate piracy by trafficking in these devices and services, and we eagerly await the coming into force of these new provisions.

We also strongly recommend the strengthening of civil and criminal remedies for commercial-scale copyright infringements, as well as the introduction of new border measures, such as empowering customs officials to make ex officio seizures of counterfeit and pirate products and circumvention devices at the border without a court order, which they're not presently entitled to do.

Similar measures have actually been introduced in the anti-counterfeiting trade agreement that is also currently under discussion.

Finally, law enforcement and prosecutors should be directed to give a higher priority to IP enforcement as part of their operations and to seek deterring penalties against those who are convicted of IP crime.

Thank you very much, and I look forward to your questions.

[The Chair, Conservative, David Sweet]

Thank you very much, Mr. Kee.

We'll now move on to questions. We'll go to Mr. Lake for seven minutes.

[Mike Lake, Conservative, Edmonton—Mill Woods—Beaumont, AB]

Thank you, Mr. Chair.

Thank you to both witnesses for giving us something to think about today.

I'll start with Ms. Lank. I had the opportunity to visit Desire2Learn about a month ago. As I was mentioning to you earlier, I was blown away by the operation. I had no idea how big the organization was. From what I understand, it is growing substantially as well. Maybe you could speak to that.

How many employees are there? It sounds like it's going to grow. To what extent is it growing, and why?

[Diane Lank]

First I'll do a little advertising. If anybody is looking for a job, we have about 170 postings on our career site right now. We're about 600 employees worldwide. About 90% of those are in Canada, the vast majority in Kitchener-Waterloo. We're soon going to be starting a small operation in St. John's, Newfoundland, but most everybody is in K-W. As a matter of fact, the only official office we have at this point, at least for this week, is in K-W.

The growth really has been phenomenal. If you say that in 2005 we were 50 and now we're 600, that was not a steady growth. When the patent litigation ended in December 2009, we were about 150 employees. Much of the growth has been in the past three years.

I don't think anyone in our company recognized the pent-up demand the patent litigation caused on both sides, both from our competitor and from us. There were a lot of prospects that had taken a wait-and-see attitude, and since then it has been phenomenal.

We're very excited by it. We have moved to new space, which is old space in K-W, and now we're looking for more space. We cannot keep up with hiring. I used to know all three people in the sales department and now it really is overwhelming. We love our Canadian base and we have no intentions of giving that up.

Some people may be aware that we just accepted our first round of financing ever, which is pretty remarkable for a company our size. We have an $80-million investment, and that investment was cross-border. Almost a half of it came from OMERS, the Ontario Municipal Employees Retirement System, and the other half came from a U.S. investment outfit called NEA.

We're really excited about that turn of events.

[Mike Lake, Conservative, Edmonton—Mill Woods—Beaumont, AB]

It's pretty exciting to see what's going on in Kitchener-Waterloo. I'm sure that Mr. Braid would share that excitement, but it was a real eye-opener for me to see that rejuvenation of the centre of the city too, in that historic area you're in. I believe you share with Google and many other companies that are doing pretty well.

It is interesting that you talk about this litigation process. In a case that you won—

[Diane Lank]

Eventually....

[Mike Lake, Conservative, Edmonton—Mill Woods—Beaumont, AB]

--it suffocated your growth. It really held back the incredible growth that probably could have happened earlier, probably at a time when the economy in that area could have used it too.

What would the company have done differently from the start? Knowing what you know now, what would you have done differently?

[Diane Lank]

That's a question we discuss internally to some degree.

Looking back on it, I think we would have been wiser in estimating the fees and costs. I don't know how you would do that, and I'm a lawyer and I'm used to doing stuff like that. Personally, I would have had more serious talks with John and others in leadership about the long slog U.S. litigation can provoke.

[Mike Lake, Conservative, Edmonton—Mill Woods—Beaumont, AB]

If you don't mind, I'm going to break in. I meant even earlier than that, though, the way your IP was set up, whatever it was that led to the litigation in the first place.

[Diane Lank]

John, by the way, sends his regrets. I know he would have loved to be here today.

He and I talked about that yesterday. I asked him what we could have done differently. I think the only possible difference would have been if we had had some patents in our defensive portfolio. That's a pretty common strategy by a lot of companies these days. It's kind of like mutually assured destruction in the old arms race: you have two patents, but we have three, and if you come after us we're going to get you. He was not encouraged to do that when he started the business. Indeed, he says he was told that what he thought were great ideas were not patentable in Canada. Remember, back in the early days he was pretty Canada-centric.

That would have been probably the only thing, short of selling out to our competitor or settling. Had we had some patents in our pockets, it might have made a difference. Remember that we were sued in 2006 over a patent that was filed in the U.S. in 1999, so there is this whole thing with prior date. Even if we had filed for a patent in 2000, the 1999 date would trump the 2000 date. It's a very difficult question to answer, other than by saying to educate, educate, educate. The young entrepreneurs, the young start-ups, have to know the risks. I know $8,000, $10,000, $12,000 to file a utility patent sounds like a lot of money, but it is peanuts compared with the millions that we spent, and that was sucked out of the economy. The vast majority of that went south, literally.