Intellectual Property and the Due Diligence Required in Mergers or Acquisitions
By Andrew J. Sherman
Posted: 9th January 2019 08:49Tens of thousands of merger or acquisition (M&A) transactions occur each year, with nearly 51,000 closing worldwide in 2017, valuing more than $3.5 trillion. Of those thousands of M&A deals, most, if not all, raised some type of intellectual property (IP) issue and involves the transfer of key intangible assets. Separately, M&A and IP are, by their nature, complex transactions; together, the intricacy and issues surrounding a deal are only increased. With careful planning, a clear understanding of the challenges ahead, competent counsel, and proper due diligence, businesses can smoothly navigate and successfully overcome the various challenges presented. This article will primarily deal with the due diligence required by various types of IP M&A deals, but you should not forget that this is just one, albeit a critical, step in a transaction.
IP laws in the United States are deeply rooted in our legal system; patents and copyrights are specifically addressed in Article I of the Constitution. Over several decades, IP law has branched out to not only encompass the constitutionally protected patents and copyrights, but also trademarks and brands, trade secrets, and trade dress. More recently, some intangible assets are also considered under IP law.
Patents. A patent grants an inventor the right to exclude others from making, using, selling, or offering to sell his/her invention throughout the United States, or from importing the invention into the United States for a limited period. Four categories of patents exist: utility, design, plant, and business model.
Trademarks and Brands. Trademarks and service marks are words, names, symbols, or devices used to identify and distinguish the products or services from one company, from those of another, and to indicate the source of the products or services. A trademark identifies a product and is typically applied physically to the product or displayed on a container or layer of a product. Service marks are used in both sale and advertising campaigns and promotional materials.
Trade Secrets. A company’s trade secrets typically consist of its confidential formula, recipes, business format and plan, prospect lists, pricing methods, marking distribution techniques, key employee data, systems, process, training manuals, pipeline reprints, partner demographics, and customer information. These trade secrets are typically protected either by duty or by contract – hence the need for confidentiality or nondisclosure agreements when proprietary information is shared with a third party that does not owe you any fiduciary obligation.
Copyrights. Copyrights are protected by the Copyright Act which protects all “original works of authorship fixed in any tangible medium of expression.” The owner of a copyright has the exclusive right to: reproduce the work, prepare derivative works, distribute copies of the work, perform and display the work publically. Importantly, copyright only protects the expression of an idea, not the idea itself.
Trade Dress. Trade Dress refers to the characteristics of the overall visual and design appearance of a product, it's packaging, or the interior décor of a restaurant or retail store or even the navigational features and design of a website. Trade dress is typically subject to protection if the combination of features used in the presentation, packaging, or “dress” of the goods and services is both nonfunctional and distinctive.
Intangible Assets. Other intangible assets can and should be considered in a similar manner as more traditional IP. Human capital, information capital, and organisation capital are some of the most important strategic assets of a company. Human capital includes the combination of an employees’ skills and knowledge as well as training and motivational systems. Information capital entails databases and other technology infrastructure. Organisational capital, perhaps the most well-known and discussed, consists of the company’s governance culture and leadership.
IP Due Diligence. Due diligence for the above-outlined IP is of paramount importance when a company is involved in an M&A transaction where the target company has an IP portfolio (regardless of whether the IP is considered a substantial asset). The acquiring company should start by determining the structure of the transaction. The form a transaction takes will impact the way the companies will conduct due diligence.
As is true with most business transactions (M&A or otherwise) open communication, detailed analysis, and a tailored strategy are vital; this is also the case when conducting IP due diligence. After the initial diligence, such as determining the materiality and scope of the IP, an acquiring company should communicate and request information from the target company including a list of all IP assets owned or used. Upon receipt of the list, the acquirer should verify, verify, and verify again. Confirm the current owner and beneficial owner, the filing or application status, any upcoming deadlines, and the jurisdictions covered by the registration or application. Far too often, an acquirer will find out after the completion of a deal that the IP it thought it owned outright is still pending or is licensed for use by another.
This brings us to the next point: identify rights and verify ownership at various stages throughout the M&A transaction. IP due diligence entails verification at several levels, including reviewing IP search reports. Before closing, specifically review whether any previously unreleased security interests have been recorded and confirm the chain of title. Verify the strength of IP rights; often IP rights are not binary and can range from very strong to very weak. Understand your position to avoid overvaluing or undervaluing an IP asset.
Increasingly, companies are putting a stronger emphasis on their IP portfolios and the IP assets are more important than ever. The IP due diligence you do today will prepare you for the closing of an M&A deal tomorrow. Principals and advisors must embrace the new reality that the lion’s share of the assets that will be transferred via M&A or otherwise over the next few decades will be intangible in nature. Protect your time, energy, and investment by creating a cohesive and tailored plan; factor your findings into your transaction structure and agreement, and follow through on your post-closing execution strategy.
Andrew J. Sherman is a partner and chair of the corporate department in the Washington, D.C., office of Seyfarth Shaw, and a top-rated adjunct professor in the MBA and Executive MBA programs at the University of Maryland and Georgetown University Law Center. He is the author of several books, including “Harvesting Intangible Assets,” “Franchising & Licensing,” and “The Crisis of Disengagement.” He can be reached at firstname.lastname@example.org or 202-828-5381. Follow him on Twitter: @AndrewJSherman.