When the internet was created, its was based on three assumptions. First, each device connected directly to the internet would need a globally unique number –- an “address” — in order to operate. Second, the 4.3 billion addresses made available pursuant to Internet Protocol version 4 (the “IPv4 Addresses”) would be more than enough to accommodate the anticipated growth of the internet. Finally, the allocation and management of those IPv4 Addresses would be best administered by five newly-minted Regional Internet Registries  –– one for North America, Europe, Asia-Pacific, Latin America and Africa (each a “RIR”).

With some technological exceptions, this first premise is generally true today. Assumptions two and three, however, have proven to be grossly incorrect.

Macro trends, such as “The Internet of Things,” social media and the never-ending demand for mobile access, have made the world more and more dependent on data. As such, the internet community needed more than the 4.3 billion originally available IPv4 Addresses to get to its current footprint.

REMAINING INVENTORIES OF ADDRESSES ARE DEPLETING

Regional absorption rates differed amongst the RIRs, and the ongoing initiatives to remedy the resulting supply and demand imbalance have had limited success. As a result, the RIRs have totally depleted –- or very soon will deplete -– their remaining inventories of internet addresses.

What happens, then, when Company X has more internet addresses than it needs, but Company Y doesn’t have enough? Traditionally, this type of transaction has been consummated through an RIR, but in doing so, Company Y must expressly agree that it did not become the “owner” of those addresses. Instead Company Y only gets a license to use those addresses — a license that the RIR can revoke.

That all changed in Richardson, Texas in March of  2011 when Microsoft paid the Nortel bankruptcy trustee $7.5 million for a large bundle of internet addresses. These particular IPv4 Addresses, however, had not been issued by, or ever involved in a transaction cleared through, any RIR. These so-called “Legacy IPv4 Addresses” were “sold” at an $11.25 per Legacy IPv4 Address purchase price.

This seminal transaction viewed these Legacy IPv4 Addresses as any other type of intangible property -– not just the subject of a revocable license controlled by the RIR. Under this approach, the Legacy IPv4 Addresses could be bought and sold through a “Gray Market” without clearing through an RIR.  Hence a new asset was born.

Various organizations such as the National Science Foundation and other commentators have embraced this same approach with differing levels of enthusiasm. But more importantly, many blocks of Legacy IPv4 Addresses have been sold in several other noteworthy bankruptcies at prices ranging from $9 per address to $12 per address.

DIFFICULT TO DETERMINE ACTUAL PRICE OF LEGACY IPV4 ADDRESSES

Unlike these bankruptcy transactions, however, the terms of most other Gray Market transactions are not publicly available, so it is very difficult to accurately determine the “average” price for Legacy IPv4 Addresses (which may vary significantly on key technical aspects) and the size of this fragmented, opaque and unsystematic market.

It is interesting to note, however, that one commentator has concluded that roughly 1.9 billion IPv4 Internet Addresses — or approximately 44 percent of the entire original IPv4 Internet Address pool — are Legacy IPv4 Internet Addresses that may be transferred via this Gray Market. Since others have claimed that $15 is the “average” market price for a Legacy IPv4 Address, the overall value of the current Gray Market has been estimated to be as high as $8 billion — a very large market, indeed, that may even increase in size as the current supply and demand imbalance intensifies.

Gray Market participants have used a variety of structures -– such as options, rights of first refusal, long-term leases, letters of agency and assignable purchase, and sale contracts — to consummate these purchase and sale transactions. Installment payments, phased delivery, seller or third-party financing and the issuance of credits to the seller to offset the purchase of other unrelated services from the buyer have also been used.

Due diligence efforts to confirm the seller’s “title” to the subject IPv4 Legacy Addresses are critical in evaluating each potential Gray Market transaction. Many Gray Market participants rely on the registries maintained by the RIRs, but these registries are frequently incorrect and out of date. Other purchasers may rely on specific technologies, but regardless of the approach taken, title is frequently a muddled issue.

To be sure, the buyer may have legal recourse against the seller for a breach of any applicable representations and warranties. It may even have a separate cause of action against the seller’s lawyer or the IPv4 Broker if they delivered written opinions at closing.  But these options -– both individually and in combination — are generally insufficient to redress the loss those Legacy IPv4 Addresses to a party with a better claim.

INSURANCE PROPOSED AS A POSSIBLE SOLUTION

Seasoned transactional lawyers recognize this familiar concern and quickly can propose the use of insurance as a possible solution. In corporate acquisitions and sales, for example, the seller may provide representations and warranties regarding title and other key points can be supported by so-called “representations and warranties” insurance.

Similarly, no substantial real estate purchase, sale or related financing transaction would ever close without the availability of title insurance in which the insurer agrees to defend the purchaser’s title to the transferred property subject to the express exclusions and other coverage-limiting provisions contained in the policy.

No insurance product currently serves a similar function in support of the Gray Market. The absence of such coverage is curious since it seems logical to assume that the willingness of a well-financed, independent third party to provide similar confirmation of title or of an exclusive right to register at an “acceptable” price would be embraced by the Gray Market. Indeed, the availability of such a spot-on product could conceivably expand the size of the Grey Market, ultimately becoming as critical to consummating such transactions as title insurance is to real estate deals and representations and warranties policies are to corporate deals.

Like these two existing coverages, a Legacy IPv4 Address insurance product would not be an absolute confirmation of title transfer or an unequivocal statement that the purchaser now has the exclusive right to license those addresses. However, it would provide a better–funded, independent source that is in the business of paying off bad bets in situations where it has crafted a carefully shaped profile that it is willing to accept.

As with any new insurance product, each interested prospective carrier would need to resolve a variety of procedural issues before writing this coverage. Evaluating the carrier’s cost and methodology to validate this opportunity, underwriting protocol and marketing issues would be important. But even after careful analysis of all of the available data, it will still require a leap of faith for the first carrier to conclude that it can charge enough for this new coverage in order to cover its costs and still earn an appropriate risk-adjusted rate of return.

HOW WOULD THE INSURANCE COVERAGE WORK?

The scope of actual coverage will likewise require thoughtful analysis of several key points. For example, would the policy only cover losses after a court has issued a final ruling that the insured is not entitled to use the covered addresses? Could the carrier company satisfy its obligations to the insured by paying the insured the “market price” of those Legacy IPv4 Addresses less the policy’s deductible? Or perhaps the carrier could replace the insured’s Legacy IPv4 Address with other Legacy IPv4 Addresses that the carrier acquires in the Gray Market or by providing the insured with other Legacy IPv4 Addresses that the carrier maintains in inventory or in a separate investment portfolio since the carrier may want to participate in the potential upside in sales prices.

As with all insurance, this new product would also include carefully crafted exclusions such as “sea changes” in the governance of the internet, intentional acts of the insured, the insured’s prior knowledge of specific defects in title to the Legacy IPv4 Addresses and the effects of pre-coverage security interests in the subject addresses.

From a macro perspective, it would seem that the willingness of a well-financed, independent third party to assume this type of risk would be embraced by the Gray Market. Indeed, the availability of such a spot-on product could conceivably expand the size of the Gray Market, ultimately becoming as critical to consummating those transactions as title insurance is in real estate deals.

Thermopylae Ventures is currently in negotiations with several major international insurance carriers -– such as Berkshire Hathaway –- to analyze, structure and market this type of insurance product. Many challenges and issues remain to be solved, but progress to date has been very promising.

If these efforts prove to be successful, perhaps DFW can be the home of yet another seismic change in the global market for internet addresses.

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