Last week, a $1.3 billion verdict was handed down against SAP AG, the German software giant, after a lengthy litigation stemming from the acquisition of a company engaged in questionable -- and ultimately infringing -- business practices. The enormous verdict underscores the importance of pre-acquisition due diligence.

A savvy house hunter conducts a thorough inspection to identify potentially costly defects such as a leaky roof or a termite infestation. Likewise, a company seeking to acquire another company takes similar precautions, typically in the form of a lengthy "due diligence" investigation of the target company -- a comprehensive audit of the target's financial health, including exhaustive research related to existing debts, liabilities, labor issues, tax matters, information technology status, commercial situation, insurance and liability coverage, and so forth. By conducting this thorough inspection of a target company, a company is better able to determine whether the acquisition makes goods business sense and, if so, the appropriate valuation of the target company and its assets. It also makes it less likely that any "termites" will reveal themselves and threaten to "bring down the house" post-acquisition.

Sometimes, of course, an apparently minor defect, like a leaky pipe, can explode and flood the entire basement. Enter SAP AG and TomorrowNow Inc., a (now defunct) company providing third-party maintenance and support services to companies licensing enterprise software. SAP acquired TomorrowNow in January of 2005 for $11.1 billion in order to compete with other companies, namely PeopleSoft, Inc. and Oracle Corporation, in the enterprise software third-party maintenance and support service arena. Last week, a federal jury awarded a $1.3 billion verdict against SAP -- reported to be the largest copyright infringement verdict, and one of the largest intellectual property verdicts period, ever recorded -- capping off the damages trial of a lawsuit instituted by Oracle back in 2007 in the U.S. District Court for the Northern District of California.

The copyright infringement claim stemmed from TomorrowNow's provision of support services to Oracle customers, which -- unfortunately for SAP -- included the alleged unauthorized copying and distribution of ordinarily expensive Oracle software and related documentation, all of which was subject to copyright protection. After admitting to (or failing to contest) both vicarious and contributory copyright infringement, the jury returned with the surprising $1.3 billion verdict -- a true outlier, and an amount normally reserved for the most egregious patent infringements. SAP, for its part, had argued for damages in the double-digit millions.

One might wonder whether SAP simply failed to see the risk, whether it identified the risk and factored it into the decision to acquire, or whether (more likely) the truth lies somewhere in between. Oracle maintained that SAP took the easy way out by purchasing and operating TomorrowNow, with knowledge of the copyright infringement, in order to get a leg up on the competition. Whatever the truth is, there are lessons to be learned, and best practices to keep in mind to ensure that your company or your clients don't end up in a similar position. IP infringement "red flags" should be identified and pursued aggressively, and identification of potential or actual infringement -- and potential damages arising therefrom -- should be evaluated thoroughly. It is also important to realize that traditional IP due diligience -- identification and evaluation of the company's intellectual property assets and the claimed rights therein -- might not uncover potential or actual IP infringement risks, and that these red flags may instead be uncovered during other stages of the due diligence process. For instance, it seems likely that TomorrowNow did not identify the Oracle-owned software and documents as its own assets. For this reason, it is critical to be mindful of intellectual property issues through each phase and each category of the due diligence process.

The SAP debacle is, without a doubt, a cautionary tale. However, it's easy for us to point out, in hindsight, that the SAP's acquisition of TomorrowNow was a terrible move, one that has ended up costing the company billions (TomorrowNow itself was shuttered in 2008), and perhaps $1.3 billion on top of that. It may well be the case that SAP properly identified the infringement risk and factored the potential liability in its offer for and acquisition of TomorrowNow -- indeed, even if evidence of clear infringement was uncovered during due diligence, a copyright infringement verdict of this magnitude may not have been foreseeable.

SAP has vowed to "pursue all available options," including post-trial motions and appeal, in order to reduce the verdict. For now, however, the massive verdict serves as a stark warning to companies, to not only conduct through intellectual property investigations of target companies, but also to take steps to properly understand and quantify any risks that are uncovered.