An Introduction to Digitalisation

Digital is Everywhere 

• In recent years the growth of the digital economy has eclipsed that of traditional markets
  
• Every business, irrespective of its core purpose, can join the digital economy
• Adoption of digitalisation is likely to be a critical determinant of future growth
• Digitalisation throws up numerous legal issues, some of them new, some of them unresolved. These need to be dealt with, but shouldn’t be allowed to stand in the way of action – now!

The digital economy is expanding globally at an exponential rate. Digitalisation of commerce is critical to improving efficiency and productivity and is the driver of innovation, competition and growth across all businesses and sectors. In our inaugural issue of Get Digital we provide a bird's eye view of key opportunities and challenges, from a legal perspective, in anticipation of deeper dives into specific areas in future issues, with recommendations for legal action in the face of the increasing reliance of businesses on technology.

In recent years the growth of the digital economy has eclipsed that of traditional markets across the globe. In the UK alone, businesses belonging to the digital economy have grown by 30% in the past five years and the digital sector has outperformed the traditional economy overall. ^1.
Digitalisation is enabled by a combination of:

• cheap ubiquitous connectivity;
• cheaper and smaller hardware (with computing power expanding in accordance with Moore’s law);
• cloud based storage; and
•  new technologies (such as virtual and enhanced reality, robots, AI, machine learning and blockchain).

These are the foundations and basic infrastructure of the digital economy. These can be deployed together with data analytics to increase efficiency and decrease costs when applied to internal business processes and, possibly more significantly, deployed together with new business models to create new revenue streams. The result has been a dramatic upturn in investment activity across all sectors (be it fintech, proptech, infratech, or any other kind of tech).

New economy deals

Digitalisation and the success of technology companies are driving market activity. In recent years, we have seen rises in:

•  the emergence of new businesses, spins offs and exits (e.g. businesses involving intelligent attendants, delivery and micro-banks);
• whole new markets (e.g. there were more than 40 acquisitions of private companies relating to artificial intelligence, automation and robotics in 2016);
•  unlikely partnerships (e.g. the City of Amsterdam partnering with MX3D and Autodesk to create a metal bridge using 3D printing);
•  collaboration between competitors (e.g. the R3 blockchain consortium);
•  corporate venturing to harness the innovation of start-ups (e.g. over 50 new corporate venturing units made their first investment in H1 2016);
•  tech fund formations (e.g. Softbank's proposed $100bn Vision Fund);
•  M&A as an alternative to R&D (e.g. in relation to data assets, such as Verizon's acquisition of Social Radar to improve MapQuest's location data); and
•  new forms of financing (e.g. P2P financing and crowdfunded IPOs).

The legal challenges

Digitalisation throws up numerous legal issues, some of them new, some of them unresolved – but that is not to say that there aren’t steps which can and need to be taken in preparation for digitalisation projects.

Data, data, data

Digitalisation allows businesses to drive cost efficiencies, gain business insights, enhance customer experiences and develop new revenue streams. For instance, sensors and location-based services make it possible to collect data on internal processes and, thereby, monitor operations and maintenance while consumer data can be collected by businesses for use in behavioural advertising, whether themselves or by selling the data to third parties.

Data is the currency of the digital economy. Technological advances offer new opportunities to deploy that currency. Ensuring that this potentially valuable asset can be fully exploited is important. Where consumer data is involved, it is vital that the anticipated collection, storage and processing of data is permitted under data protection legislation. Stricter rules on data profiling will come into play under the new General Data Protection Regulation (the GDPR), compliance with which will be mandatory from 25th May 2018.

Where businesses rely on the exploitation of data, key considerations run beyond compliance. In many cases large datasets are created with data input from business partners. Businesses will need to work out the provenance of their data (does it come from other businesses? The State?). It is important to ensure that there will be continued access to data on a known cost basis and to understand whether there is freedom to commercialise compiled data.

Data reliant businesses are well advised to make sure they have (or put in place) the right data access arrangements (for example escrow arrangements guaranteeing access should the supplier ever fail) and the right contractual framework in order to ensure guaranteed supply. They will also need comfort that the data will be clean and accurate and has been collected, stored and processed lawfully.

Compliance

Compliance can be a particular headache when rolling out new business models or looking at acquiring early stage companies. This can be related to the application of law, whether existing (are Uber drivers really employees rather than self-employed? Is renting out a property on Airbnb an unlawful sublet?), or new (will the use of drones for aerial photography be restricted? How will competition law evolve to deal with the challenges thrown up by the digital economy?).

Assessing whether compliance issues will affect the sustainability of a new business model is further complicated because of the tendency of the business models of early stage companies to flip faster than their compliance analysis. Nevertheless, targeted due diligence and risk assessment is advised in order to assess what is being acquired, to secure appropriate warranties, possibly put in place structural separation and assemble a plan to get any issues identified fixed

Cyber security

As businesses become increasingly tech-centric, it becomes ever more important to ensure that the right legal protections are in place to maintain suitable systems, ideally with rights to conduct technical audits. Systems should include firewalls, anti-virus and anti-spam software. Proper due diligence is required, in the context of commercial arrangements and M&A, to ensure that counterparties also have appropriate measures in place (evidenced by appropriate certification). The development of and compliance with standards is only likely to grow.

Businesses are recommended to have their cyber-incident response teams and processes in place and thoroughly tested (through wargaming). Cyber risk insurance may be appropriate, but should be carefully negotiated to ensure it is fit for purpose.

Connectivity 

 As businesses become increasingly reliant on access to data, agreements for the provision of connectivity have grown in importance, in particular around the negotiation of KPIs, cyber security and liability provisions. Telecoms regulation also comes into play in this context.

Intellectual property

Intellectual property is a key feature of the digital economy, where the analysis can be complicated by factors such the increased predominance of partnerships giving rise to the possible co-mingling of IP and often unsatisfactory discussions around co-ownership.

Consideration should be given to all aspects of IP, including designs and patentable innovations, as well as neighbouring rights, such as database rights. Businesses should identify when and how new intellectual property is likely to be generated. As some intellectual property may be vulnerable to invalidation through misuse, business should make sure that their internal use policies are up to date and regularly shared with staff, alongside detailed use guidelines and prohibitions for any licensees.

Copyright is a complex area of intellectual property law, not least because the right is not registrable in many jurisdictions and often comes about automatically on creation, which can lead to questions over ownership (before even considering whether the work product of artificial intelligence qualifies for protection under copyright). It is, therefore, essential to document evidence of creation of the work and any right to use it under licence.

Sometimes overlooked is the increased use of open source software, often published under a warranty-free licence, possibly requiring any program that incorporates the open source code to be made freely available, curtailing the ability to exploit proprietary software – careful due diligence and rights management is recommended.

Labour law

Digitalisation by its nature gives rise to unintended consequences. Thus - increased reliance on technology and automation will render a lot of tasks formerly undertaken with human intervention redundant. This can lead to layoffs and industrial unrest which is, in turn, leading to a resurgence of the need for certain skill sets in industrial relations and employment law. Any business which currently relies on a significant workforce would do well to prepare for this.

M&A and Financing of Digitalised Businesses

Digitalised businesses are different and this needs to be acknowledged. Inherently more complex and more connected technology risk and business risk.

An informed approach is, therefore, required, with a proper understanding of the market and technology risks guiding the analysis of the legal risks and, most importantly, the development of appropriate legal solutions.

In M&A, this analysis will assist in developing appropriate warranty and indemnity packages. (often around intangible assets – notably IP and data, as well as licences, which may well be subject to restrictions and change of control provisions), but it will also go towards assessing value and determining consideration (which may be particularly relevant in the context of businesses which have yet to show any profit).

Another challenge may be preserving the value of certain assets on insolvency since these are likely to be more heavily interdependent on other parts of the "ecosystem" than in the past, when it may have been more realistic to divest tangible assets, such as real estate, on a stand-alone basis.

The growing importance of “partnering” arrangements also presents challenges since these are unlikely to withstand a change of control.

Issues of value won’t just arise in M&A, they are also relevant in financings – to the extent the credit is secured, creditors will need to understand where the business's value really lies, and who owns and controls that value in order to structure a meaningful credit support package.

Dispute Resolution

Digitalisation and the accompanying increased reliance on technology can significantly change a business' profile for potential disputes. A software or AI error could lead to individual or class actions for the error if it affects customers, suppliers or other third parties. There may be a claim against the software provider for the resulting losses, but a tech start up with significant debt, could be a man of straw.

The increasing storage and use of customer data brings data protection and security concerns and liability for leaks. A leak through a cyberattack or otherwise may also give rise to third party claims and to potential disputes with Cybersecurity insurers in relation to coverage. Where new products or services are launched and new markets created, businesses which secure market share may face regulatory or competition law challenges from competitors who have lost out.

Technology is also changing the conduct of disputes. Multiple parties across several jurisdictions may be involved. There may be a race to launch legal proceedings to secure the most favourable jurisdiction, if exclusive contractual jurisdiction clauses have not been properly negotiated. There may also be inter-related contractual and tortious claims some of which under the relevant contract are subject to arbitration others of which in relation to any non-contractual parties are subject to the jurisdiction of the local Court. The conduct of such claims will, increasingly, require sophisticated project management skills as well strategic and legal insight. The burden of document review in court cases increases as the amount of electronic data available balloons and the different types of communication to be searched multiply. Personal data must be redacted. Parties may need to explain the workings of their technology to lay judges and arbitrators, with expert witnesses to assist. All of this is driving the legaltech market, with the adoption of increasingly sophisticated document review software and artificial intelligence by law firms in order to increase efficiency and control costs.

Don’t miss out

As with any new developments, digitalisation gives rise to uncertainties and complications. However, success has always meant thinking ahead - and right now that means thinking about digital. Quite simply, if a company doesn’t have a digital strategy, it doesn’t have a strategy and without a strategy, it may not have a business.

Over the coming months, we will go on to examine key features of the digital economy, highlighting the opportunities for businesses and identifying the legal challenges and appropriate strategies for dealing with those challenges.

We will focus on investing and financing digital businesses; data as an asset; Introducing new technologies and business models, competition law and compliance.