M&A: IP Due Diligence

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These days, the most important group of assets of a company is often its intellectual property (“IP”), which includes patents, trademarks, trade dress, copyrights, trade secrets, domain names and other proprietary information and materials. Due to its mercurial nature, IP requires special consideration and attention in acquisition transactions, whether as part of an asset purchase, a stock purchase, a merger, or an investment in a company.

Why is IP Due Diligence Important?

Failure to include all IP assets in a due diligence investigation can have a significant impact on the true value of the acquisition.

For an acquiring company, IP due diligence is crucial. Otherwise, the acquiring company cannot correctly value the selling and might significantly overpay for the assets it acquires. Even worse, the acquiring company could be purchasing an IP infringement lawsuit.

Perhaps the greatest cautionary tale supporting the use of IP due diligence is a 1998 purchase by Volkswagen, AG. Volkswagen bid and paid $795 million for Rolls-Royce Motor Cars Ltd., but soon discovered that the “Rolls-Royce” trademarks were not part of the deal. Rolls-Royce PLC had gone into receivership in the 1970s and, although Rolls-Royce Motor Cars, Ltd was sold at that time, the “Rolls-Royce” trademark was retained by Rolls-Royce PLC. At the end of the day, Volkswagen had spent $795 million for a luxury car company, but could not use the Rolls-Royce brand.

IP due diligence should also be conducted by the selling company in preparation for the negotiation of the terms of the deal. For the seller, IP due diligence allows it to better ascertain the value of its IP assets, and therefore overall worth. It also permits the seller to clean house and ensure that all registrations, licenses and assignments are current, properly executed and recorded – which can help avoid problems that might impede a smooth closing.

Develop an IP Asset Inventory

Before the parties can properly value the IP assets of the selling company, they must carefully review a full and accurate inventory of all IP assets, an “IP Asset Inventory”.

Although IP is treated as personal property under the law, ownership of IP is, “title” (or “paper”) based like land and other real estate property. As such, the ownership of IP is generally determined through review of contract and registration documents, rather than being primarily determined by possession of the IP assets.

Much information regarding pending and registered patents, trademarks, copyrights and domains can be gleaned from publicly available sources such as the U.S. Patent and Trademark Office (USPTO) and the U.S. Copyright Office, as well as foreign registries and databases. In addition to registration and ownership information, these sources often contain details regarding the IP assets such as prosecution history, chain of title, etc.

The public portion of the IP Asset Inventory may include:

  • Published patent applications

  • Patents

  • Trademark applications and registrations (state, USPTO, and/or international)

  • Trade names

  • Advertisements, newsletter and similar public communications

  • Copyrights registered with US Copyright Office

  • Domain URLs

  • Social media accounts

Additionally, the acquiring company must also evaluate the selling company’s non–public IP assets, lest it base decisions on only a partial view of the entire IP Asset Inventory. Of course, prior to releasing such information, the selling company should require the parties to enter into a non-disclosure agreement (NDA) to protect its proprietary IP assets.

The non-public portion of the IP Asset Inventory may include:

  • Non-published patent applications and related materials such as patentability or prior art searches;

  • Unfiled or unregistered trademarks and related materials such as clearance searches;

  • Trade secrets and confidential business information;

  • Licenses and assignments relating to the IP assets;

  • Employee manuals and training materials; and

  • Letters and other communications relating to litigation, claims of infringement, title disputes, or other adverse action related to the IP assets.

Conducting the IP Due Diligence Investigation

After obtaining the information described above, the acquiring company can more fully evaluate the risks and benefits associated with the proposed transaction. Although each situation is unique, an IP Asset Inventory evaluation should involve the following steps:

  • Step 1: Review the IP Asset Inventory to determine the selling company’s rights with respect to each of those IP assets (e.g., owner, co-owner, license, etc.).

  • Step 2: Review any active litigation, settlements, coexistence/consent agreements, assignments, and any other agreements affecting the selling company’s rights in the IP assets.

  • Step 3: Ensure that the IP is enforceable, and that registrations are current.

  • Step 4: Assess the value of the IP. Analyze the value of the IP as it relates to current production and future expansion of the business.

IP Assets and the Transaction Documents

Once the diligence has been conducted and the parties wish to move forward with the transaction, they must ensure that all IP assets are properly identified in the various lists, schedules and exhibits to the transaction documents. In addition, to protect the buyer, the seller generally makes representations and warranties regarding the seller’s ownership of the IP, the lack of infringement of third-party IP, etc., and agrees to indemnify buyer for any costs of claims resulting from the failure of seller’s representations and warranties.

Post-sale IP Filings

Following closing on the transaction, the IP assets transferred to the buyer must be delivered to the buyer. To formalize the transfer, assignments must be recorded with the USPTO, Copyright Office, and any other state, federal or foreign IP registry to indicate the new ownership of the IP assets.

Law, Corporate & Commercial, ArticlesJim Chester