PROTECTING INTELLECTUAL PROPERTY IN M&A TRANSACTIONS: WHY CONDUCT A PROPER DUE DILIGENCE

Mergers and acquisition transactions can be extremely complex and a wide array of factors have to be considered when undertaking them. In most transactions, parties generally assume the intellectual property (IP) rights will automatically transfer with the purchase of an entity or its business or assets, and that any post-closing intellectual property issues can be cured solely by securing strong representations and warranties. Whilst it is important to do so, relying on breach of representations and warranties as the only remedy to protect the acquired IP can result in unexpected surprises after closing that halt or challenge intended business plans of the buying entity. Such was the case in the 1998 acquisition of Rolls Royce assets by German car maker Volkswagen (estimated transaction value $900,000,000). It wasn’t until closing that Volkswagen realised that the acquired IP assets did not include the right to use the Rolls Royce trademark. The trademark was owned by BMW pursuant to a prior agreement between Volkswagen and BMW. Volkswagen had therefore bought the necessary rights to manufacture the car but did not have the right to brand it as a Rolls Royce.

The above story highlights the importance of conducting a proper and thorough due diligence in the acquisition process. Generally, there are four major areas that such IP due diligence should focus on:

1.              Ownership of IP rights

A review of the ownership of a target’s IP assets will reveal if indeed the target owns the IP assets it claims or believes to own.   Such review must be undertaken by conducting searches at the relevant patent, trademark and copyright offices to establish that:

i)               all IP assets capable of registration have been duly registered and are up to date with the relevant filling office;

ii)              any transfers or changes in ownership can be traced or ascertained and where applicable, registered;

iii)            there are no assignments of the IP assets to third parties; and

iv)            there are no encumbrances that may restrict the utilisation of such IP assets.

2.              Control of IP rights

A target may have entered into prior agreements (assignments or licences) that restrict the use of its IP assets. The due diligence process should include a review of such agreements and identify any restrictions that may apply to the buyer of such IP assets.  

3.              Potential liability or infringement claims

A well conducted due diligence will also reveal if a target company is infringing on the IP rights of a third party or faces exposure due to allegations of IP infringement. The buyer’s legal counsel will look at any known litigation or threatened litigation and advise on the potential liability the target faces including evaluating potential indemnities that the buyer may require of the seller.  The due diligence should explore the target’s history and procedures for obtaining or registering its IP rights to ensure that the target is not infringing on the IP rights of third parties. 

The buyer’s legal counsel should also review the target’s procedures for protecting and enforcing its own IP rights against infringement by third parties. This kind of review will for example examine the target’s procedures for tracking and enforcing its IP rights against infringement by third parties and for maintaining quality control over the use of it IP assets by licensees.

4.                Encumbrances

As is the case with many classes of assets, the target’s IP assets can be encumbered and the due diligence process should reveal the extent to which such assets are encumbered. Searches at the relevant registries will show the existence of any encumbrances which could include security interests, liens or licenses. If such encumbrances exist, the buyer may opt to reprice the value of such IP assets or require that the seller procure their release, in which case buyer’s legal counsel should confirm that all necessary releases and discharges have been obtained and filed or recorded.

In an M&A transaction, IP due diligence is a valuable tool in assisting the buyer evaluate the economic value of the IP assets to be acquired by comparing the IP assets strength, scope, limitations and quality against the buyer’s (and the target’s) business objectives and goals post acquisition.  It is commonly used by buyers to re-evaluate the transaction or enter into repricing or restructuring negotiations with the seller.