Checklist: IP Due Diligence for M&A Transactions

AdobeStock_399603265-scaled-e1661534259751-300x195Here is a checklist for buyer’s counsel to use when conducting a legal due diligence review of intellectual property (IP) and information technology (IT) matters as part of a merger or acquisition (an M&A transaction). The checklist covers common areas of due diligence concerning intellectual property (IP) and information technology (IT) matters in relation to a merger or acquisition (an M&A transaction).

When you are preparing for any kind of M&A transaction, you will want to be sure that you retain legal counsel for assistance with many of these concerns. A Silicon Valley business law attorney with Structure Law Group, LLP can be by your side the entire time and ensure that you achieve the most favorable end result.

Common Pitfalls or Deal Breakers

Every deal will be different, but here are some of the most common pitfalls and potential deal breakers that a Silicon Valley mergers and acquisitions attorney may find during due diligence.

Chain of Title Concerns

A very common pitfall you may uncover during your due diligence is a chain of title issue for an IP asset or possibly multiple IP assets. This issue often occurs when a company acquires an IP asset from a third party, and there is no update to the title for the new owner, or there is no update to the title to the IP assets for corporate name changes or lien releases. If there is a duty contractually or under the law to assign, then there is a remedy for chain of title issues without much issue. If there is no duty to assign, however, the buyer could want to require that the seller obtain, at their own expense, all of the rights to the IP asset prior to the transaction closing.

Key IP Jointly Owned With a Third Party With No Obligation to Assign

Joint ownership of IP can frequently result from a collaborative arrangement with a customer to improve an existing product or possibly with a consultant or contractor to improve or create a new product. While it may sound fair that an invention is jointly owned by a company and the party, joint ownership can create multiple business and enforcement challenges. Under the United States patent law, a joint owner that makes, uses, sells, imports, or licenses an invention covered by the jointly-owned patent will not have to share any money they receive from doing so with any other joint owner of the patent. When a seller and a third party are joint owners of a U.S. Patent, the potential buyer should remember that the third party could operate as a competitor and may be free to license the jointly-owned patent to a competitor.

Missing IP

There may be a failure to include crucial IP in a deal by accident or maybe some other reason. It is important to verify that a buyer acquires all of the IP assets, or the rights to use those IP assets, as it relates to a seller’s business as it exists and as the buyer plans to conduct the business in the future.

Burdensome IP Clauses in Unexpected Places

While IP ownership clauses may be in certain agreements, unexpected agreements may hide some IP ownership clauses. These clauses may sometimes transfer rights to improvements in products or services to the customer and then give the customer a non-exclusive license to the underlying technology for as long as the customer utilizes the improved product or service. Such obligations can be difficult, and a prospective buyer could want to avoid them.

Government Funding Rights

If an invention is entirely or partially funded by the federal government, then the government will have a nonexclusive, irrevocable, paid-up license to practice the patent that covers the invention. Under the Bayh-Dole Act, a funding agreement will include a Preference for U.S. Industry clause, which precludes a receiver of government funds or assignee from granting the exclusive right to use or sell in the country any invention that is under patent coverage unless the products incorporating the invention or production of the invention are manufactured substantially in the nation. You could have a federal funding agency grant a waiver upon showing that there were reasonable yet unsuccessful efforts to grant licenses on similar terms to potential licensees that could be likely to manufacture in the United States or that under the circumstances, domestic manufacture is not commercially feasible.

Assignment and Change of Control Issues

Anti-assignment clauses in an IP license or other important IP agreements that preclude all assignments will be a deal breaker if the subject IP is important to the buyer. Similar clauses restricting assignment or conditioning assignment can also create issues. You should also review termination clauses in agreements because some will allow non-assigning parties to terminate agreements in the event of non-permitted assignments, or agreements automatically terminate upon such a transfer.

Patent Scope Is Narrow or Does Not Cover Key Products

The claims in a patent will define the scope of its coverage, and sometimes an analysis of the patent you want to acquire may indicate that the patent claims do not cover the key commercialized products they were supposed to cover or may be easily designed around by a competitor to evade coverage.

Limitations Exist on the Use or Expansion of a Trademark, or Registered Trademarks May Not Cover Key Goods or Services

Some trademarks or service marks could be subject to concurrent use agreements or other agreements that limit rights. A concurrent use agreement will be an agreement on how two parties can use a mark, and this agreement may include detailed geographic divisions. Agreements restricting a trademark or service mark owner from expanding into goods or services other than those for which the mark’s current registration applies can also be deal breakers because these agreements are typically enforceable. Yet another pitfall can involve trademarks used on key commercialized goods without registration for use in connection with those goods.

Abandonment, Lapses, or Expiration of Patents or Trademarks

Abandonment, lapses, and expirations often occur when there is a failure to pay maintenance fees or annuities or missing other deadlines at patent and trademark offices. Buyers should always verify a schedule of upcoming deadlines for every IP asset in regards to fees that must be paid or office action responses have to be filed and require the seller to maintain all IP assets up to closing.

Trade Secret No Longer a Secret

A trade secret can include formulas, devices, patterns, techniques, compilations, methods, programs, or processes. The trade secret needs to have an actual or potential economic benefit and must be the subject of reasonable efforts to maintain its secrecy. Trade secrets can be valuable because they may be enforced for as long as they are actually maintained as secrets and provide economic benefit. The pitfall many people encounter during due diligence is a seller having little documentation of procedures to maintain the secrecy of these secrets or sellers no longer following those procedures.

Key Patent or Trademark Applications Are Too Early in the Prosecution Process to Determine Scope With Any Degree of Certainty

Claims of a patent application can be somewhat broad upon initial filing in an attempt to obtain the broadest possible coverage. You could see narrowing many claims, and the scope of potential patent coverage is difficult to determine with certainty early in the prosecution process. As it concerns trademark applications, goods, and services for which there is a filing for a trademark or service mark could need to be narrowed during prosecution to obtain a registration.

Terminal Disclaimers

The United States places a judicial prohibition on patenting obvious variations, meaning terminal disclaimers are sometimes filed in a pending patent application to overcome a non-statutory double patenting rejection. After the filing of a terminal disclaimer, an applicant will state that the subsequently issued patent has the same term as a previously issued patent, and both patents will be commonly owned. The pitfall that can occur is that both patents will not be commonly owned, and the patents subject to the disclaimers become unenforceable.

Representations, Warranties, and Indemnifications

A buyer will want clearly defined representations and warranties with regard to the definition of IP, the seller’s ownership of IP, infringement of seller’s IP, and non-infringement of third parties’ IP. A buyer will always want to guarantee that there is not any IP missing from a deal that relates to the conduct of the acquired business, and the IP Schedule describes all rights relating to licensing an acquired business to third parties and rights licensed from third parties.

It is also common to require a representation from a seller that a seller owns all of the rights to all of the IP they are transferring. A buyer can also negotiate for a representation from the seller that there has been no claim by any third party, no claim is outstanding, or there is no threatening of any claim contesting the use, enforceability, validity, or ownership of the IP.

To avoid stepping into a dispute that the other party does not disclose during due diligence, a buyer could seek a representation that a seller did not receive notice of and is not aware of any facts indicating a likelihood of any misappropriation or infringement by or conflict with, a third party, and that seller has not done anything to infringe, misappropriate, or otherwise conflict with any rights of any third parties. Even when there is no present anticipation of potential litigation related to IP assets, a buyer will still want to obtain further assurances that a seller will provide assistance in any enforcement action or in defensive litigation related to IP assets.

A buyer could also seek to obtain a seller’s continued confidentiality of information they are transferring and sharing related to IP assets and enforcement or defense of the IP rights you are transferring. Additionally, a buyer will want to obtain assurances that the chain of title of each IP right they are transferring is clean at the time seller assigns such right to the buyer, such assignments are not in violation of any other agreements, and the seller must provide assistance when needed so the buyer can update the chain of title following closing.

In order to avoid abandonment of an IP asset during due diligence, a buyer often requires a representation from a seller that a seller maintains the IP rights up to closing.

A seller could, on the other hand, want to limit representations and warranties with qualifying language and exceptions to the IP Schedule so that the representations and warranties are reasonable. A buyer occasionally requests a representation relating to the use of IP assets in the acquired business, but sellers will avoid having to make such a representation.

A buyer will also want indemnification for breaches of representations and warranties and for known claims, even future claims related to IP. A buyer often wants to negotiate a longer survival period for IP claims than the survival period for general representations and warranties, and, especially when there is currently litigation, they could want a special indemnity or escrow of money when there is any risk of a substantial judgment.

A buyer could also want to control the defense and settlement of third-party claims against the acquired asset, which may be true even if a seller is paying for the legal costs via indemnification.

A seller will want to negotiate to limit indemnification, possibly through IP assets taken as-is, thresholds, use of money deductibles, indemnification caps, or possibly caps on timeframes for indemnification events or claims. While a right to control defense of third-party claims and settlement consent may be requested for indemnified legal costs, buyers are typically averse to such a proposal even though sellers will usually want to negotiate for IP indemnification to end when the survival period for general representations ends.

Call Us Today to Schedule a Consultation With a Silicon Valley Business Law Attorney

If you are in the process of an M&A transaction involving IP, be sure that you have a Silicon Valley mergers and acquisitions lawyer on your side. Structure Law Group, LLP can examine the details of your deal and make sure you have full protection.

Our firm understands the complexity of M&A transactions and knows how to deliver results. Call (408) 441-7500 in Silicon Valley or (310) 818-7500 in Los Angeles, or contact us online to receive an initial consultation that will allow us to examine your case and provide legal guidance thoroughly.