Intellectual Property Issues in the Sale of Business

Introduction

A Corporation or a Company passes through many phases like Mergers, Acquisitions, Amalgamation, take-over, etc. for various purposes. Thus, a company may acquire another company for its expansion. Businesses are sold either by the purchase of the stock in a corporation or through a purchase of assets used by the business to be sold. When companies combine their core competencies through Mergers & Acquisitions, tangible as well as intangible assets of the Target Company forms the part of the cash flows to the Acquiring Company. The most significant of these acquired assets is Intellectual Property[1]. The article discusses the intellectual property issues that a company faces when it is in the process of selling

Methods for acquiring the business

There are three different methods for acquiring the business of another corporation under state law:

A Stock Purchase
An Asset Purchase
Merger.

Issues in Mergers and Acquisitions in Intellectual Property

Intellectual Property is now a key factor behind Mergers & Acquisitions. Intellectual Property is incentivizing parties to pursue deals to gain a foothold in a newly competitive market, expand global market share and customer base, or to gain an advantage over competitors with acquiring significant assets. It could be said that IP plays an important role, especially when it comes to technologically driven M&A transactions, but Mergers and acquisitions present many challenges to a buyer and a seller, particularly when it comes to Intellectual Property related issues[2]. Because the value of IP assets is a deciding factor for whether or not the business transaction will take place.

Intellectual Property Documentation

The seller needs to have prepared for the acquirer’s review an extensive list of all of the following IP (and related documentation) that is material to the seller’s business, including[3]

Patents and patent applications (including patent numbers, jurisdictions covered, filing, registration, issue dates)
Confidentiality and Invention Assignment Agreements with employees and consultant
Trademarks and service marks
Key trade secrets and proprietary know-how
Technology licenses from third parties to the selling company
Technology licenses from the selling company to third parties
Software and databases
Contracts providing for indemnification of third parties for IP matters
Open-source software used in (or used to create) the seller’s products and services.
Claims for infringement of IP, including any IP litigation or arbitration
Domain names
Liens or encumbrances on the IP
Source code or object code escrows
Social media accounts (Twitter, Facebook, LinkedIn, etc.)

With effective strategies and resources, the buyer and seller can anticipate these issues and hence can prepare to resolve the same.

Sourcing, Preparing and Collecting Documentation

Is one of the significant issues in mergers and acquisitions is collecting documentation required to assess and reassign the IP assets, The comprehensive set of documentation, including patents and patent applications, trademarks and service marks, trade secrets and proprietary information, licenses between the seller and third parties, contracts and agreements regarding the IP assets has to be provided by the seller, and further documentation for any IP litigation claims and domain names has to be attached therein.

It is suggested to conduct due diligence as soon as possible because it provides a good amount of time to both the seller and the buyer to collect the necessary set of documents mentioned above. Because the documentation provided by the seller to the buyer in due diligence will add as much value as possible to the corporate transaction to make an uptight deal. Ideally, the seller should have maintained an up-to-date IP portfolio with all the necessary documentation.

Intellectual Property Ownership

It is a most common issue which deals with misrepresentations or false ownership. Normally when a seller claims ownership of an IP asset, it has to provide representations and warranties to the buyer in the assignment agreement. But in the case of mergers and acquisitions, this can cause issues if the seller has misrepresented their ownership of an IP asset of a third party who has a part of the ownership of the IP asset or the seller has licensed the asset to a third party as well. But to protect the buyer the seller needs to ensure the responsibility of representations and warranties and must effectively transfer to the buyer in the assignment, so any claims of any asset cannot be made against them following the sale. To mitigate this risk, both parties seek a definitive agreement to protect themselves from the event of misrepresentations or claims.

Open or Potential IP Disputes

IP claims have a significant impact on the value of an acquisition. Most importantly a detailed review of open or potential disputes in case of intellectual property issues that may have a significant financial impact on the buyer and/or seller following a transfer agreement must be made. The buyer will seek to discover any resolved, unresolved potential claims and limit obligations to those claims. Other claims of data protection and privacy issues can have a similar impact and must be considered at the time of due diligence.

Disclosure Schedules

Mergers and acquisitions can be relatively quick transactions for several reasons. Once a potential sale becomes public knowledge, it can harm both the buyer and the seller. For instance, the seller may be subjected to IP claims from third-party opportunists. Or the buyer may find themselves competing with offers from other interested parties. So, both parties will generally prefer a swift transaction as possible. To facilitate a speedy sale, the buyer will provide a disclosure schedule to the seller, outlining the key disclosures for the seller to provide within a given timeframe. This is a complex and detailed document that, if not completed correctly, can cause intellectual property issues during and after a sale. It should include a comprehensive list of required disclosures including, but not limited to patents, patent applications, licenses, contracts, trademarks, claims, indemnifications, and financial agreements.

This document is extremely important but can cause issues for the buyer as it is time-consuming to complete and requires a high level of attention to detail for accuracy.

Due Diligence

If acquirers ignore or undervalue the potential of IP, they can weaken negotiation strategies, reduce the chances of securing future licensing agreements, and damage their ability to obtain financing. To fully understand a target’s IP portfolio, acquirers must undertake due diligence. The goal of due diligence is to assist the buyer in assessing the value of a prospective acquisition, to identify and mitigate potential risks. Through due diligence, the buyer is better able to assess the risks and to build an accurate picture of the assets and liabilities. Conversely, failing to undertake adequate due diligence can lead to an overvaluation of the target, expose the acquirer to unknown risks and liabilities, and create integration problems which could undermine synergies. “The difficulty lies in the fact that IP portfolio analysis is complex, requiring specialist knowledge to find potentially problematic points.”

Given the financial and legal importance attached to IP, dedicated due diligence should not be ignored or dismissed. In transactions that feature hundreds or even thousands of patents, it is clear that a considerable amount of work must be done – and quickly – as part of an IP investigation. Buyers need to prepare for the rigorous of due diligence and have the ability to investigate the strength and enforceability of the IP in question. “M&A transactions usually take place under extreme time pressure, so it is crucial to focus the analysis on the issues relevant to the transaction in question.

Dispute avoidance

Acquirers also need to undertake a detailed review of any potential disputes that may have a financial impact post-close, such as IP claims, which could affect the value of the acquisition. During due diligence, the acquirer must assess the risk of the target company’s potential liability from future claims by competitors and other parties, including former employees, former consultants, and current employees. A detailed review of settlement agreements and court opinions or orders relating to the target’s IP assets should be made. Warranty and indemnity (W&I) insurance can address specific and general risks, effectively hedging them with monetary compensation. The policy is typically negotiated alongside the sale agreement and taken out at the time of signing, coming into force on completion of the sale. W&I insurance has seen a significant increase in popularity in recent years. It is used in a wide variety of deals and often facilitates completion.

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Cross-border challenges

In the cross-border M&A context, there are many post-merger challenges that can jeopardize value creation – including IP management. For multinational companies, their IP portfolio often contains international IP rights, which adds to the complexity of an IP audit. Local nuances may also complicate IP due diligence. As an example, if a foreign investor wishes to acquire a German target company, it is prudent to consider the implications of German employee invention law, according to “Dr. Winkelmann”. These specific legal regulations lead to the considerable risk that the true owner of a patent is not the company entered in the register, but the inventor as a private individual, which could result in considerable risks for the buyer,” she says. “Since this is not apparent from the official patent register, detailed analyses are necessary if the buyer wants to avoid unpleasant surprises in the future.

Another example is the situation when a German investor acquires a target company abroad and wants to integrate the local development department into his or her innovation process. In some countries, it is necessary for inventions to first be registered in the inventor’s home country, which might collide with the filing strategies of European companies.”

Post-close portfolio management

After the completion of a transaction, it is important that the acquired IP portfolio is aligned with the strategic objectives of the buyer. The insight and understanding of the IP portfolio gained in due diligence should be used to plan and develop these IP rights for future value. “Parties should examine which parts of the IP portfolio are to be used for which business models and products after the transaction and which parts are less relevant for the future and can be exploited elsewhere. Though acquirers should conduct an IP audit before completion, it is advisable to repeat the process post-close, which may highlight gaps in protection and help to map out the change of ownership for the acquired IP rights.

If a change of ownership is not recorded on the relevant registers, the buyer may not be able to enforce or exploit those rights against third parties. However, this can be a costly and time-consuming process. Different jurisdictions have their requirements and fees, from completing simple documentation to more onerous processes that impose strict time limits and include higher fees. For transactions to be successful, acquirers must have full sight of the assets they are acquiring. While assets such as real estate, equipment, inventories, and financial instruments were previously the main focus of due diligence efforts, today it has become essential to prioritize IP assets, as they are often the lifeblood of an organization.

Conclusion

With the advent of technology, acquiring high standard technology in the business can give the company a huge market monopoly power. Upstream technology can help save transaction costs and downstream technology can assist in developing new products and technologies. Corporate diversification strategy is the rationale behind acquiring unrelated technology. Technology knowledge transfer in M&A deals (know-how, know- what or know-who) creates problems as far as Intellectual Property Rights are concerned, as it differs from the transfer of products in the following ways-

Exchange of knowledge cannot be reversed and there are huge chances of the disclosed trade secrets being exploited and infringed.
Every country has different laws regarding knowledge protection (in the case of International M&A) so there arise cases of Jurisdictional Issues.
Assembling the necessary parts of knowledge required to develop future IP is a complex task and Due diligence is such a process that many firms lack the capability of conducting the same.
In certain cases, it is difficult to verify if a specific piece of knowledge has been used and to figure out the know-how in conformity to the asset.

References:

1. Kelvin King, ‘The Value of Intellectual Property, Intangible Assets and Goodwill’, 7 JOURNALS OF INTELLECTUAL PROPERTY RIGHTS 245 (2002).

[2] https://blog.brandstock.com/intellectual-property-rights-merger-acquisition-issues-t2o

[3] Key Intellectual Property Issues in Mergers and Acquisition

shttps://www.forbes.com/sites/allbusiness/2016/03/17/13-key-intellectual-property-issues-in-mergers-and-acquisitions/#1f804f363f4e By Richard Haroch, Mar 17, 2016,02:53pm EDT.